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distribution, and contains a portion of 
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Professional Courses in Accountancy and 


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UNIVERSITY OF ILLINOIS LIBRARY AT URBANA-CHAMPAIGN 


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TuEoRy AND PRACTICE OF ACCOU NTS 
APPLIED ECONOMICS AND ORGANIZATION 


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. HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


LECTURE] 


THE FOUNDATION 


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_ COPYRIGHT, 1914, BY 
HOMER ST. CLAIR PACce. 


PACE & PACE 
PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 


AND ENGLISH, IN RESIDENCE AND BY EXTENSION 
30 CHURCH STREET, ine: aie AES 1 f YORK CITY 


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JAGIODH 


THEORY AND PRACTICE OF ACCOUNTS 
APPLIED ECONOMICS AND ORGANIZATION 


BY TOMER ST. CLAIR: PACE, Cy P. A. (N.Y.) 


LECTURE I 


S¥ 


THE FOUNDATION 


Wealth 


Articles that cost an effort to produce and that satisfy the needs or 
desires of mankind are known as wealth. 

For example, wild fruit that is gathered and made available for food 
costs an effort and satisfies a need, and is an article of wealth. 

The locomotive, a machine that aids in the transportation of things 


‘and persons, is a more complicated instance. Its manufacture involves 
' the gathering of natural products, the mental effort of the inventor, the 


_ physical labor of the workman and mechanic, and the work of the trader 


in making the various exchanges. 
Air, on the other hand, while supplying the most urgent of necesst- 
ties, is common to all without effort. It has, therefore, under usual con- 


ditions no economic value, and is not wealth. 


The articles that constitute wealth vary in their character from those 
that satisfy the primary needs of food, clothing and shelter to those that 
satisfy the desire for adornment or other luxury, without regard to actual 
needs. 


The Right of Property 


The ownership of the articles of wealth, it is believed, was first held 


é in common by the members of the family or tribe. Community owner- 


ship early gave way to individual ownership. With the latter there crime 
- into existence the right of property, which is the right of one individual 


to the possession, use and enjoyment of something, in nearly all cases an 


article of wealth, to the total exclusion of every other person. 


Copyright, 1914, by Homer St. Clair Pace, 


Z 


Inasmuch as the use of certain articles of wealth is essential to exist- 
ence, and the possession of others conduces to comfort and pleasure, the 
determination of the respective property rights of individuals is a matter 
of interest and consequence. 


Units of Measurement 


The exercise of exclusive rights over property presupposes an interest 
in the extent of the ownership. The savage who claimed the ownership 
of his weapons undoubtedly preferred as many as he could conveniently 
use to a less number, insufficient for his needs. 

One of the chief incentives for an enumeration, or count, is thus 
found, and it is supplied by the method: of numbering—one, two, three, 
etc.—that is used to some extent by all races, civilized or uncivilized. 
In this way, an idea of the number or extent of things is expressed. 

Many articles in their nature lend themselves conveniently to meas- 
urement in mere numbers. Thus, it may be said that there are forty cars 
in the train, and that there are ten trains a day for six days of the week. 

Numbers are divided into convenient groupings, as for example, gross 
or score, and by custom the terms are applied to certain things, as a dozen 
of eggs or a gross of pens. Another common grouping is into ten, or mul- 
tiples thereof. | 

Other things are measured more conveniently by a special unit. Thus, 
wheat is measured by the bushel, fluids by the gallon, coal by the ton 
and cloth by the yard. Numbers are relied upon, however, to convey an 
idea of the extent of the units, and thus it is said that ten tons of coal 
will supply fuel for a house, or that forty bushels of wheat are contained 
in the load. 

It is obviously inconvenient to state an aggregate ownership of the 
articles of wealth in the various units of measurement, for it would be 
necessary to state it in bushels, yards, gallons, etc. It was done in this 
way at one time, however, and there are records in existence that show 
that taxes in ancient governments were levied and paid in terms of quan- 
tity measurement, such as measures of grain. 

For the aggregate measurement a common denominator is required, 
in which all property rights may be stated. Such a unit has been in use 
for thousands of years, and is known as money. It is a medium by which 
wealth, and the effort expended to produce wealth, may be measured. 

Money is itself divided into convenient units, known variously as 
dollars, pounds, francs, etc., and they are expressed in numbers, which 
are essential to all enumerations or counts. 


Oe - SS —— ———— 





3 


Each article of wealth has a worth, known as value, that may be 
expressed in the required number of units of money. Thus, four bushels 
of wheat may be valued at one dollar a bushel, or four dollars, while a 
cord of wood may be valued at three dollars. The owner of both ‘pos- 
sesses values to the extent of seven dollars. It is obvious that the articles 
have been reduced to a common basis, comparable with all other articles 
of value. 


Money serves another purpose in that it is a token of effort expended,) ” 


exchangeable for the products of other effort. By its use, the producer 
may sell his product, taking an agreed value in money, which can be held 
in convenient form until he finds a seller of those things which he desires. 
A new exchange is then made, the seller taking his pay in money, which 
he in turn can convert into goods, and so on. 


Prerequisites 


The foregoing, that is to say, wealth, the right of property and a 
unit of measurement, are necessary prerequisites to the development and 
use of a scientific method of stating the extent of property rights, and 
determining their increase and decrease. | 

Wealth supplies the subject matter, or articles, the value of which 
is to be stated. 

The right of property, by which one individual has exclusive rights 
in the things that are essential to his existence and that satisfy his tastes, 
is accompanied by a desire for a knowledge of the extent of the owner- 
ship, and its fluctuations. 

The unit of measurement, money, as applied to the value or worth 
of property rights, provides a common measure that is essential to the 


comprehension of the extent of ownership. 


Definitions and Distinctions 


Accounting is the science of recording and stating facts in relation 
to the acquisition, production, conservation and transfer of property 
rights or values. 

Accounting has a theory, or body of underlying principles, upon 
which is based a practice, involving the construction and use of all records, 
statements and devices needed to record and state values and their transfer. 

Auditing is the verification of the accounting record that, presum- 
ably, is made in accordance with the theory and practice of accounting. 

Law, so far as accounting is concerned, supplies all necessary rules 
and regulations in relation to the acquisition and disposition of property 
values, and all transactions incident thereto. . 


4 ) 


Accountancy is a profession, the practice of which involves a general 
academic education and a special or technical training in Accounting, 
Auditing and Law. 

The members of the profession of Accountancy, known as account- 
ants, offer their services to the public in the construction, installation and 
operation of accounting systems, the presentation of accounting facts, the 
verification of accounting records, and in such other matters as their 
special training may justify. 

The object of these lectures is to present the theory and practice of 
Accounting, as above defined, in its fundamental aspects. The lectures 
provide the basic technical training for the practice of Accountancy and 
for private employment upon accounting records. 


Accounting Objects 


The science of accounting has two principal and well defined objects, 
namely: 

1. The determination, at any desired time, of the financial position 
of an individual or enterprise, that is, the possession of values and the 
liability for values. 

2. The determination, for any period of elapsed time, of the increase 
or decrease of values of an individual or enterprise. 


Accounting Essentials 


Three essentials must be met in an accounting record in order that 
the objects of accounting may be fully secured, namely: 

1. Original Position. The financial position of the individual or 
enterprise, that is, the possession of values and the liability for values, at 
the beginning of the accounting period, must be determined and recorded. 

This meets, for that moment of time, the first object of accounting, 
and provides a statement against which comparisons may be made with 
subsequent financial statements. 

2. Chronological Record. A record of the financial transactions 
subsequent to the time of starting, in the order of dates, must be made. 

This provides a record of the acquisition and transfer of values that 
affect the original position, and supplies material for achieving the second 
object of accounting. 

3. Rest. There must be a rest, or time at which the accounting 
record momentarily ceases, for the determination of the financial position. 

This provides a statement that may be compared with the statement 
showing the original position, and, if the second essential is properly 


Se ee 


. = 
_ ee 


5 


met, the two positions may be reconciled by a tracing of the transactions 
affecting values. 

The time, usually a year, that elapses between the two financial 
positions and during which the chronological record is made, is known 
as the accounting period. 

The calendar year, that is, the period from January 1st to December 
3ist, inclusive, is the ordinary accounting period. 

A fiscal year may be any consecutive twelve-months’ period, such 
as the twelve-months’ period from July ist to June 30th, inclusive, that 
constitutes the business year adopted by railroads. 

The accounting period is usually the same as the fiscal year, irrespec- 
tive of whether the latter is for the calendar year or some other twelve- 
months’ business period. 


Bookkeeping 

The systematic and chronological recording of facts as to the owner- 
ship and transfer of values is known as bookkeeping, and is the medium 
through which accounting results are obtained. 

The term accounting is more comprehensive than the term book- 
keeping, as there are several systematic records for recording financial 
facts, any of which may be called bookkeeping. The term accounting 
embraces all methods of bookkeeping. The two methods in common use 
are known as Double Entry and Single Entry. 

The system of Double Entry bookkeeping, so far as can be traced. 
appeared in Venice and Genoa in the fourteenth century, and was known 
as the Method of Venice. More than a century later, in 1494, a monk, 
Luca Paciola, published the first treatise upon Double Entry bookkeeping. 
The first English work upon the subject, by Hugh Oldcastle, a school- 
master, was published in London in 1543. Several fairly complete works 
appeared in England and America early in the nineteenth century. 

The system that Paciola set forth is now the recognized standard 
of bookkeeping. It remains unchanged in principle, and it has been 
changed in practice only to save labor and to meet the different condi- 
tions under which business is now transacted. 

The term Single Entry has a restricted meaning, as will be explained 
in a subsequent lecture, although under Single Entry bookkeeping may 
be grouped all the methods and devices, other than Double Entry book- 
keeping, by which the attempt is made to record values and the transfer 
of values. 

Single Entry has gradually given way to Double Entry until now 
it is rarely used except in small retail undertakings. 


6 


Double Entry Theory 


The system of Double Entry has become the standard of bookkeeping 
because, by its use, the objects of accounting are accomplished with the 
least effort. | 

Double Entry bookkeeping is based upon the theory of a natural law 
of compensation or balance. In nature there are many instances of a 
division of things into two parts, effecting a balance or equilibrium. For 
example, there are two poles, north and south, there is an east and a west, 
day and night, male and female, etc. : 

This natural law of balance or equilibrium supplies the fundamental 
principle of Double Entry bookkeeping. Considering the first object of 
accounting, that is, the statement of the ownership of values, it will be 
seen that the theory of balance, or equilibrium, can be applied, for the 
total of such net values must equal the worth of the owner. Thus, in 
the case of an individual possessing values to the extent of ten thousand 
dollars, the values and the worth of the owner constitute a balance or 
equilibrium, as follows: 


Vales. (a . $10,000 Worth of Owner... $10,000 


The application of the principal to transactions subsequent to the 
statement of the initial ownership will be considered later. 


Double Entry Definitions 


In accounting, things of value owned, and the right to receive val- 
ues, are known as assets, They may be classified for the purpose of 
accounting as follows: 


1. Real property, that is, land and all buildings and fixtures that 
are permanently attached to the land; 

2. Personal property, including all things of value other than real 
property, such as merchandise, money, and the right to receive values, 
such as accounts receivable, or amounts due from others known as 
debtors. 

The debts due to others, known as creditors, in accounting are 
termed liabilities. Liabilities present an element the inverse, or oppo- 
site, of assets. 

The net worth of an individual is the amount of his assets, less the 
amount of his liabilities, and is known in accounting as capital. It is 
the amount by which the assets exceed the liabilities. 

In the economic sense, an individual’s capital is the total, or gross 
amount of assets he possesses. Thus, if the total assets in a business 


7 


amount to $25,000, the economic capital is $25,000, although there may 
be $10,000 of liabilities. In such a case, however, the accounting capital 
would be only $15,000. 

Throughout all accounting, unless otherwise specified, the term cap- 
ital is used in the latter sense, and means the excess of asset values over 
liabilities. | 

The assets of a trader, or merchant, to illustrate the definitions 
given, are $20,000 and his liabilities are $10,000. The accounting capital, 
therefore, $10,000, is the amount of the excess of assets over liabilities. 

It is obvious that assets — liabilities + capital. The condition may 
be displayed in a form similar to the one previously given, as follows: 


[OC Re Oe $20,000 Liabilities........ $10,000 
Capital (to 

balance) ~ ake: 10,000 

$20,000 $20,000 


The initial balance, or equilibrium, necessary to open double entry 
books of account when the assets exceed the liabilities, can always be 
established in this manner. No matter into how many items the assets 
and liabilities may be divided, the excess of the total amount of the assets 
over the total amount of the liabilities is the capital, and the amount 
necessary to establish a balance. 


Original Position 


In opening double entry books of account it is necessary to determine 
the first essential of accounting, or original position. 

The assets and liabilities are inventoried and displayed in opposition, 
in the manner before indicated. Assets are carried to the left side of the 
statement, and this position to the left, or debit, side is maintained for 
assets throughout all double entry. The liabilities are carried to the 
right, or credit, side, and always thereafter appear on the credit side. 

The capital, while not a liability in the sense that it is an amount 
due a creditor, is an amount showing the accountability of the business 
to the owner, subject to the payment of the liabilities. It must appear 
with a credit balance to effect a balance or equilibrium. 

The initial statement is variously known as a Statement of Assets 
and Liabilities, Statement of Affairs, and Balance Sheet. The two 
latter terms are perhaps best reserved for other statements, to be described 
later. In the construction of such a statement, let it be assumed that 
John Doe started in business January 2, 1902, with $5,000 in cash and 


8 


$9,000 in merchandise values, with no liabilities. The condition would be 
displayed as follows: 


JOHN DOE. 
STATEMENT OF ASSETS AND LIABILITIES AS AT JANUARY 2, 1902. 
ASSETS. CAPITAL. 
Cash Gs cipeek Ais eet see t $5,000 John Doe, Capital...... $14,000 
Merchandise........... 9,000 
$14,000 $14,000 


As an illustration of a more complicated case, Richard Roe started 
in business July 1, 1902, with $1,000 in cash, $2,500 in accounts receiv- 
able, real estate valued at $15,000, upon which there was a bond and 
mortgage (liability) for $8,000. There was six months’ interest at six 
per cent. due on the mortgage. 

The procedure is to list the assets and liabilities and carry in Capital 
to balance, thus: 

RICHARD ROE. 


STATEMENT OF ASSETS AND LIABILITIES AS AT JULY 1, 1902. 


ASSETS. LIABILITIES. 

Sah eee eee ee eee es Po Bond & Mortgage ..... . $8,000 

Accounts Receivable (as Accrued Interest........ 240 
per Schedule)........ 2,500 
Reali Rstatete sc eae iO 

‘(otal Assets iii ae $18,500 Total Liabilities.... $8,240 

Capital. occ epee 10,260 

$18,500 $18,500 


The principle is the same in all cases. The object is to find the net 
capital or investment by listing all assets and all liabilities as they stand 
on the day the statement is dated. 

Interest that is accrued, but not due, is as much a liability as the 
bond itself, for the bond may not be due to be paid for several years. 
Therefore, accrued interest and all similar items, whether assets or liabil- 
ities, must be taken into the statement. 

In the rare case of an excess of liabilities over assets, the amount 
necessary to effect a balance must be carried to the left side, as a deficit 
or deficiency. It constitutes an element the inverse of capital, or an 
accountability for values beyond those owned. 


9 
The Journal 


The position of the individual or undertaking having been thus ascer- 
tained and a statement constructed on the double entry principle of making 
the total debit items equal the total credit items, the actual opening of 
the books of account, by the transfer of facts, is in order. 

In double entry bookkeeping, the Journal, in one form or another, 
is the book in which the original record of the business is kept from day to 
day, including the statement of the original assets, liabilities and capital. 

The most common form of Journal is a bound book, ruled, beginning 
at the left, with columns for date, a wide column for names of accounts, 
a narrow column for ledger page or folio (abbreviated L. F.) to which 
posting is made, and two money columns, one for debits and one for 
credits. The ordinary ruling is, therefore, substantially as follows: 


(Debit (Credit 
(Month) (Day) (Names of Accounts) 1 oA Se Money Money 
a 3 Column) Column) 


In transferring the facts from the Statement of Assets and Liabil- 
ities the same relative positions are maintained in the money columns, 
the assets being carried to the left, or debit, column, and the liabilities 
and capital to the right, or credit, column. 

Upon the basis of the first Statement of Assets and Liabilities of 
John Doe, and following the rule stated, the opening Journal entry would 
be as follows: 


10 


New York, January, 1902. 


2 
CASH osc o eek ih okt tek eee $5,000 
MERCHANDISE, ¢.35) Hake Be 9,000 
To JOHN DOE, Capital........... $14,000 


For assets (no liabilities) of John Doe, 
who this day engages in the business 
Ofc TOUe ote ets eee wea Meee 


once 6. > 66 21 S.e ere @ @ & piles bie be ce. rele 26,6 Bo 0e 


It is obvious that it is a reproduction of the Statement of Assets 
and Liabilities, except that the money columns are adjoining. 

The above entry means that Cash is debtor for $5,000, that is, Cash 
is debited with it. The meaning of this is clearer when one thinks of the 
cash as turned over to the cashier or placed in a drawer, in which case 
the cashier or the drawer is accountable, or debtor, for the amount and 
should be charged with it. 

The entry also means that Merchandise is likewise chargeable with 
$9,000 of value and must account therefor. 

The entry means further that John Doe is to be credited with $14,000, 
for, considering the business as a thing apart from himself, he should 
receive credit for the capital he contributes. The credit indicates the 
accountability of the business to the proprietor. 

The old way of expressing the entry would be Cash, Dr., Merchan- 
dise, Dr., To John Doe, Cr. The Dr. and Cr. abbreviations are now 
dispensed with, but the To remains in use, so that the usual form is as 
given above. 

The best method is to place the name of the city or town in which 
the business is located, with the month and year, at the head of the Journal 
page, and the day of the month in the center immediately above the entry, 
as shown in the foregoing illustration. This obviates the necessity of 
using the column to the left of the page for date, which can be utilized for 
some other purpose. | 

Considering the more complicated condition shown in the second 
example, the opening entry would be as follows: 


11 


New York, July, 1902. 








GASH: stra Abas: Jaan dae ise $1,000 

ACCOUNTS RECEIVABLE........ 2,500 

REA IESPATE 20) O00 eT ai 15,000 
To BOND & MORTGAGE....... $8,000 
“ ACCRUED INTEREST...... 240 
“ RICHARD ROE, CAPITAL.. 10,260 


For assets, liabilities and capital of 
Richard Roe, who this day engages 
ty the: fusiness Ofs 0) ey 4 ee 


w Ee er 6 16 10 Oe isn ea i 8 a ee eee) bike rw) ee ie el Sie: ee! 6 


In the foregoing, Cash, Accounts Receivable and Real Estate are 
accountable for the respective amounts with which they are debited. 
An account would be opened with each debtor, but here, in the absence 
of details, Accounts Receivable are treated as one account. 

The liabilities, Bond & Mortgage, and Accrued Interest, are credited 
with the respective amounts to show the liability of the business on account 
of each. The Capital Account is treated as in the foregoing illustration. 

The form will become impressed with subsequent work. It is here 
important to understand that assets are carried to the debit column, and 
liabilities and capital to the credit column. 

In Journal illustrations hereafter given, no rulings will be shown, 
but merely the accounts affected, which will be sufficient to show the 
principles of debit and credit. 

In each entry the total placed in the debit column must equal the 
total placed in the credit column, to preserve the equilibrium of the work. 


The Ledger 
Not only the opening entries, but also every subsequent transaction, 
might be recorded in the Journal, and a complete record of the business 
kept in this way, as will be seen as the system is unfolded. 
It is easily seen, however, that it would be necessary to classify or 
index the record in such a way that all entries bearing upon a particular 


12 


subject, as, for instance, Cash, could be ascertained, viewed and con- 
sidered as a whole. Thus, if the amounts for which Cash is accountable, 
are recorded by debits, a summation of such debits is necessary to dis- 
close the total accountability. Without such an arrangement of items, 
the Journal record would give little or no idea of the facts of the business. 

This classification of facts is made by carrying or posting the Journal 
entries to accounts, in a book called the Ledger, each account having 
a debit and credit side. Journal debits are posted to the debit of Ledger 
accounts, and Journal credits are posted to the credit of Ledger accounts. 

A Ledger account is a collection, under a distinctive caption, in a 
book called a Ledger, of the debits and credits pertaining to a particular 
person or subject. 

The Ledger ruling resembles the Journal ruling in that there are 
debit and credit money columns, although the arrangement, in the ordi- 
nary Ledger ruling, is different, and more nearly resembles the form 
shown for the Statement of Assets and Liabilities. 

Starting from the extreme left of the page, the ruling is, columns 
for month and day of month, column for explanations, column for Journal 
folio, that is, page of Journal from which amount is carried, and money 
column for debit items. This consumes the left half of the page, and 
the right half is ruled in a similar manner, the money column being for 
credit items, thus: 


(Debit (Credit 
(Month) | (Day) | (Explanations) | F. | Money ||(Month) | (Day) | (Explanations) | F. | Money 
Column) Column) 





The Ledger is the book in which the principal facts recorded in the 
Journal are collected in accounts, each account with the caption, and 
the debits and credits appertaining to that account, as determined and 
shown in the original record in the Journal. 

The total debit of each Journal entry being the same as the total 
credit, it follows that if the entries are correctly posted to the Ledger 


13 


accounts, the total debits of the Ledger accounts will always equal the 
total credits. 

By ascertaining whether the debits and credits of the Ledger ac- 
counts are in balance, a valuable check is provided upon the accuracy 
of the postings. 

In the first example of Journal entries given, three accounts would 
have to be opened in the Ledger, and after posting, they would appear 
_as follows: 


CASH. 

1902 
Jan. 2 To John Doe, 

Capital..... 1 | $5,000 

MERCHANDISE. 

1902 
Jan. 74 To John Doe, 

Capital..... 1 | $9,000 


JOHN DOE, CAPITAL. 


1902 
Jan. 2 By Sundries..| 1 | $14,000 


The explanation in the Cash Account To John Doe, Capital, means 
that Cash was debtor To John Doe, Capital, credit. It names the ac- 
count that received the credit, so that, by glancing down the debit col- 
umn of the Cash Account, the accounts that received the various credits 
can be determined, without reference to the Journal. The same explana- 
tion applies to the Merchandise Account. 


14 


The By Sundries in John Doe, Capital Account, means that more 
than one item (Cash and Merchandise) was debtor to that amount. In 
case one account only were debited, it would be named, but if more than 
one account is debited, it is customary to use the term Sundries. 

The date and folio column in the illustrative Ledger accouats are 
self-explanatory. 


The Basic Books 


The Journal and Ledger are the two essential books in double entry 
bookkeeping. By their use, every necessary record and classification can 
be made. 

A complete record may, in fact, be maintained in either alone, but 
on account of lack of classification, as explained, the Journal without 
the Ledger is inadequate. 

On the other hand, debits and credits may be made directly to Ledger 
accounts in the first instance, without passing through a Journal. Such 
a procedure, however, does not afford a record that may be considered in — 
chronological order; it burdens the Ledger accounts with a mass of detail 
not needed in the classification of transactions, and, in general, opens 
the way to omissions and errors. 

Practically, both Journal and Ledger are necessary for successful 
work in double entry bookkeeping. 

As all other books are but forms of the Journal and Ledger, a thor- 
ough mastery of the principles of these books will materially simplify the 
further consideration of the double entry bookkeeping fabric, which rests 
upon the few principles and three essentials that have been outlined. 











THEORY AND PRACTICE OF ACCOUNTS 
Reece APPLIED ECONOMICS AND ORGANIZATION 


_ By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE II 


_ THE RECORD OF TRANSACTIONS 


i GENERAL View. coc. uc). AON Se ea On Ue eae cue, 45 
REAL, PERSONAL AND NominaL Accounts............° 19 
Pe PURCHASES 0S) 02. a ety SSN ok ee re ae 19 
ae ena Are ae 20 


-- RETURNED PuRCHASES AND RETURNED SALES.......¢.. 20 


ie i WIVISION OF MERCHANDISE’ ACCOUNT..../i.04 Obs eos 21 
ee: . - Prorir et Sti ge R a pit hers Se we ee as 21 
poe _ Diviston op EXPENSES INTO ACGOUNTAL Lc) Samer te ee 
i RCC U Ni Ale etre he a a: 23 
a ee RECEIVABLE AND BILLS PAYABLE. Baa heh UL Bot ey Da 

Distinctions BETWEEN EXPENDITURES......5.0 005.0. sel 

COPYRIGHT, 1914, BY 
HOMER ST. CLAIR PACE. 
tek PACE & PACE — 
: in o PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
vie ‘AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


: os 30 CHURCH STREET, | a 0k NEW WORK CITY 











THEORY AND PRAcTICE OF ACCOUNTS 
APPLIED ECONOMICS AND: ORGANIZATION 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE II 


THE RECORD OF TRANSACTIONS 


General View 


The object of the commercial undertaking, under ordinary circum- 
stances, is to make a profit. In a trading concern the effort to secure 
such profit takes the form of buying at one price and selling at a higher 
price, the difference in the buying and selling prices, or Gross Profit, 
as it is usually termed, being large enough, presumably, to cover all the 
expenses of the undertaking and to leave a balance, which is known as 
Net Profit. 

In the illustrative Statements of Assets and Liabilities that have 
been considered, the Capital Account measures the net asset value, or 
net worth, of the undertaking. 

Especially in the first example, in which there are no outside liabili- 
ties, but merely assets on the left side, balanced by the Capital Account 
on the opposite side, it is apparent that the Capital Account is but a 
measurement of the values that exist contra, or opposite. 

This is always the function of the Capital Account—it indicates to 
the proprietor the amount of his net investment in the business, or, as 
some choose to express it, it shows the liability or accountability of the 
business to the proprietor. 

If profits are earned by exchanging assets for assets of greater value, 
and the profit is not withdrawn from the business, there must be an in- 
crease in the capital or investment to the extent of such profit. 

If expenses are incurred in making such turnover, they must be 
deducted from the Gross Profit in order to arrive at the net increase in 


the investment or capital. 
Copyright, 1914, by Homer St. Clair Pace. 


16 


Stating the proposition arithmetically, if the initial Cap- 


ital was... SS QORY Po SE haa Pee Cr coe $900.00 
and the GrossiProfitasicwics 6 Ae eae. eee $200.00 

by deducting the expenses incurred in securing such 

Gross Profits: coer gear eas ins 5 URE R enn Re, > emma 75.00 

we arrive,at the Net |Profitac ys area. . ae 125.00 


which, if left in the business, would increase the Capital to $1,025.00 


Stating the same proposition from the Double Entry accounting 
viewpoint, bv raising a Capital Account, it is as follows: 


CAPITAL ACCOUNT. 


To Expensesi = simone bey wes peed $75.00 By Balance, >. .0. 7p cnn ee eee $900.00 

















RL BOLGNCE GOWN oe ck i oho nena 1,025.00 “ Gross ‘Profit. - 2.622: 224 200.00 
$1,100.00 $1,100.00 
By Balance). .:.s004 «5 8 eee $1,025.00 


It thus appears that, if losses and expenses are charged to Capital 
Account, and profits are credited to Capital Account, and there are no 
withdrawals by the proprietor, the balance of the Capital Account will 
be larger or smaller just as the business makes a net profit or loss. 

Instead of making such charges and credits directly to the Capital 
Account, it 1s customary to raise intermediate, or temporary, accounts, 
that hold the items of expense and profit in suspense until the close of 
the interval of time, usually one year, which is known as the accounting 
period. 

Scrutinizing more closely the items of expense and loss, it is found 
that they are either paid by turning over an asset as where rent is paid 
by cash, or they are taken into the accounts by setting up a liability, 
as where rent is due to another and is credited to an account opened in 
his name. 

It follows that such expenses and losses must be debited, either to 
take the place of the asset which is surrendered and therefore credited, 
or to balance the liability which is credited, as will be more fully illus- 
trated later. 


17 


Profits, on the other hand, consist of increased assets and are meas- 
ured by credit balances. 

Thus, if the business has. $500 of merchandise, the Merchandise Ac- 
count will be debited with that amount, and if it should be sold for cash 
for $600, Cash Account would be debited with the $600 received and 
Merchandise Account would be credited, leaving Merchandise Account 
with a credit balance of $100.’ 

That is, a profit of $100 has been earned, which consists of cash, and 
it is measured by the credit balance of the Merchandise Account. 

Assets and expenses (including losses) being debited, and liabilities, 
capital and profits being credited, it follows that an account with a debit 
balance is either an asset or an expense, or a combination of the two, and 
that an account with a credit balance is either a liability, capital or a 
profit or some combination of these elements. 

By the method of raising intermediate accounts, instead of carrying 
items of profit and loss directly to Capital, all the items of a certain kind 
are brought together in an account. For example, all payments on ac- 
count of salaries are charged to Salaries Account. 

This classification of expenses and profits is of use in the conduct of 
the business during the accounting period through comparisons which 
can be made with similar classifications of former periods, and it is of 
value in the preparation of analytical statements at the close of the ac- 
counting period. 

At the completion of the period the balances of the Nominal accounts, 
as they are termed, carrying profit and loss elements, are brought together, 
usually by Journal entries, in a ledger account called a Profit & Loss 
Account. 

It is necessary to bring all losses and expenses to the Profit & Loss 
Account by charging the latter and crediting the particular expense 
account, thus: 


jg ald pul Bos wl bs pee ei rane ie peek ea ug eee ai 
Shay Sid D7 Red MOBS SR Lah 7 AOE ie RATE 


It is necessary to bring all profits to the Profit & Loss Account by 
crediting the latter and charging the particular profit account, thus: 


LH RE Sn (received ies eh bes eis Pata bin on 
MOsPROR UE x lLOSoeisenwe. js awa o ks vs 


The construction of a Profit & Loss Account is merely a gathering 
in one Ledger account of the items of profits and losses, offsetting them 
against each other. 

If the total of the profit items exceeds the total of the loss items, 


18 


the excess, being a credit balance and measuring increased asset value 
in the business, is carried to Capital Account, thus: 
BROPUTT ae hhOSS ite a, Oe 300) ab RAS a ee 
TOpGAPITA Ls 225 its Sate gee eae 

The foregoing entry balances the Profit & Loss Account, and clears 
the books, at that particular moment, of all Nominal accounts. If a 
loss is incurred, it is carried to Capital by a debit entry and Profit & Loss 
Account is credited to balance. 

If drawings had been made by the proprietor during the accounting 
period, they would have been charged, properly, to a Drawing Account 
or Personal Account opened in his name, the balance of the Profit & 
Loss Account would first have been taken to such account, and the bal- 
ance, measuring the net increase or decrease of investment in the business, 
would have been carried to the Capital Account. 

Instead of raising a separate Drawing Account and charging it with 
withdrawals, they are sometimes charged directly to Capital Account. 
The method of keeping withdrawals in a distinct account, and carrying 
the amount of the net increase or decrease of capital to the Capital Ac- 
count and thereby showing the net result without a multiplicity of items, 
is preferable. 

This view of the Profit & Loss Account is now given in order to show 
its relation to the Nominal accounts, and that it is merely a consolidation 
of such elements and the gateway through which they find their way to 
the Capital Account. 


It is important that the general plan be grasped by the student in 
order that the goal to be attained, and the general means of reaching it, 
may be clearly in mind before, as well as during, the consideration of 
the details which is about to be undertaken. 

Therefore, to reiterate, the books are opened with the assets on the 
debit side, and the liabilities and Capital on the credit side, effecting an 
equilibrium, or balance. 

During the transaction of the business for the period, Nominal, or 
temporary, accounts are raised, to which expenses are charged and to 
which profits are credited, and at the end of the period these accounts 
are closed into one, and the net profit or loss is offset against drawings 
in the Drawing Account, and the balance is carried to Capital Account, 
and marks the increase ar decrease of net asset value in the business as 
the result of the transactions for the fiscal period. 

After the Nominal accounts are closed out, the books, so far as the 
nature of the accounts is concerned, are in the same condition as when 


19 


opened—assets appearing as debits to accounts, and liabilities and Cap- 
ital as credits to accounts. 


Real, Personal and Nominal Accounts 

The temporary accounts, raised in the course of the accounting 
period, to be offset and closed out, are known as Nominal accounts, and 
their nature has already been sufficiently noted. 

As distinguished from Nominal accounts, those accounts represent- 
ing real facts as to the ownership of values, such as Cash, Real Estate, 
Machinery, Plant, etc., and the liability for values, such as Accounts 
Payable, are known as Real accounts. 

Accounts with persons, either with debtors, those indebted to the 
business, or with creditors, those to whom the business is indebted, are 
also known as Personal accounts. 

Personal accounts are, in fact, Real accounts, although they are 
often given the distinctive classification. 

Another classification of accounts is into Personal and Impersonal, 
the former being those with persons, and the latter all other accounts. 
This classification seems to be illogical, because the Impersonal accounts 
include those representing asset values, such as Real Estate, and those 
representing nominal elements, such as Rent, thus associating elements 
of entirely dissimilar character. 

The most logical division would seem to be into Real accounts, sub- 
divided into accounts with persons and accounts with things, and Nom- 
inal accounts. 

Upon the opening of a set of books only Real accounts ordinarily 
appear, but upon the transaction of business Nominal accounts are raised, 
and remain until closed out at the end of the accounting period. 


Purchases 

The business of a trading concern provides transactions that illustrate 
the principles of accounting, and although a comprehensive theoretical 
view of the transactions of an accounting period has been given, it will 
now be reinforced by entries covering specific transactions. 

The first procedure in a trading business, is to buy stock. It may 
be bought for cash, in which case Merchandise would be charged and 
Cash credited, the following Journal entry covering the principles of debit 
and credit: 

tive SRM Oue Vou OS OST Op es CES ee Oar eae 
PROM Cy Eda Set, Gideon Shee covet tie as 

That is, the transaction is merely an exchange of an asset of one 

kind for an asset of another kind, and so it appears in the books as raising 


20 i 
an asset by a charge to Merchandise, and the cutting down of another 
asset by a credit of an equal amount to Cash. 

If the purchase is made upon credit, Merchandise would be debited 
and the person or concern from whom the purchase is made would be 
credited, as follows: 

MES CIAMN DIDE.. cucu satetan ou ene eee Oe 
Too WEELTAM JONES, cue. steerer cee 

That is, the transaction amounts to obtaining an asset by incurring a . 
liability of an equal amount, and it is carried out in the books by charging 
the assets and crediting the person or concern to whom the business is 
indebted for the asset. 

In either event, whether one asset be raised and another cut down 
by a like amount, or whether an asset be obtained and a liability of a 
like amount be incurred, the net condition of capital is not changed. 


Sales 


Sales, in the natural order of things, follow purchases. Like pur- 
chases, they may be for cash or on time. If for cash, Cash is charged 
and merchandise credited, with the amount of the sale, thus: 


for Cash should be charged, that is, it is accountable for all cash received, 
and Merchandise, having been charged with the cost of goods, should be 
credited with the amount received for goods which have been sold and 
which have passed out of stock. 

If the sale is on credit, the person to whom the goods are sold should 
be charged in an account opened in his name, and a credit should be made 
to Merchandise the same as in the foregoing illustration, thus: 


for the business now has an asset in the account receivable. 


Returned Purchases and Returned Sales 


Goods are sometimes returned to the one from whom they were 
bought and are then known as Returned Purchases. The one to whom 
the return is made should be charged, and Merchandise credited, thus: 

WILLIAM JONES: 23 552 pee eee ce 
TO MERCHANDISE. 2 aa Ateneo 
for, to the extent of the return, it is the extinction of a liability by the 
turning over of an asset. 


21 


In like manner, customers of the business may return goods, and 
such returns are known as Returned Sales. In such cases Merchandise 
is charged and the customer credited with the amount, thus: 


for, to the extent of the return, it reduces an asset and restores the Mer- 
chandise Account to its former position. 


Division of Merchandise Account 


In the accounts of traders, a Merchandise Account is usually 
maintained, to which purchases are charged, sales credited, returned 
purchases credited and returned sales charged, in the manner which has 
been set forth. 

A better and more modern method is to divide the Merchandise 
Account into two ledger accounts, viz., Purchases, to which purchases 
are charged and returned purchases credited; and Sales, to which sales 
are credited and returned sales charged, the Purchases Account showing 
the net purchases, and the Sales Account the net sales. 

Or, if the volume of business justifies it, a further division may be 
made by opening a Returned Purchases Account and a Returned 
Sales Account. 

The Merchandise Account is a consolidation of these various ele- 
ments, and while it theoretically gives the same result as the division 
into separate accounts, practically the amount of net sales and net pur- 
chases cannot be determined, from time to time, as readily; the com- 
parison of purchases and sales with previous periods is difficult; the 
Merchandise Account in practice frequently becomes the resting place of 
many items which are not otherwise easily disposed of; and, in short, 
it falls short of giving the satisfaction that is obtained by making the 
division into distinct Purchases and Sales accounts. 


Profit 


If the selling price differs from the purchase price, the new element 
of profit or loss enters into the accounts, for in that case the selling is 
not exchanging one asset for another of equal value, but for one of a 
greater or less value. Ordinarily, of course, the exchange is for an asset 
of a greater value, and a profit is made. 

If the accounts are opened with Purchases and Sales accounts, and 
all the goods on hand are sold, there will be on the books a Purchases 
Account, debited with the cost of the goods, and a Sales Account, credited 


22 


with the selling price of the goods. It is a simple case of cost, as shown 
in the Purchases Account, as against proceeds, as shown in the Sales 
Account. The excess of the proceeds over the cost is the Gross Profit 
made in the trading transactions. 

If no expenses were incurred in these transactions, and no drawings 
made by the proprietor, the excess of the Sales Account over the Pur- 
chases Account would be the net increase of assets on account of the 
trading operations, to be finally taken into the Capital Account. 

In practice there would be expense items to be charged against the 
Gross Profit, but this does not change the principle in the least. 

Practically, it seldom happens that the goods are completely sold 
out, for the purchases and sales go on continually. But if the goods on 
hand are inventoried at cost prices, and the amount deducted from the 
cost of the goods as shown by the Purchases Account, it is evident that 
the balance will be the cost of the goods sold. 

To express it tersely, cost of goods bought, less cost of goods on 
hand, equals cost of goods which have passed out of stock. 

This being true, it is easy to arrive at cost against selling price, as 
was done in the theoretical case where the goods were all sold. The exact 
method of doing this will be considered in the next lecture. 


Division of Expenses into Accounts 


The Nominal accounts raised in the course of the business have to 
do principally with the items of expense, and just how many accounts 
shall be raised is a matter dependent upon the particular business and 
the requirements of its management. ) 

In any event, the principal items of expense, such as wages, rent, 
insurance, freight, cartage, etc., are collected in distinct accounts. 

When such expenses are paid in cash, the proper account is charged 
and Cash credited, and if not paid in cash, the proper account is charged 
and the party to whom the undertaking is liable for the amount receives 
the credit. 

Thus, if it is a cash payment for rent, the entry is: 


for an expense is incurred, which should be charged, and it is met by 
cutting down the asset of cash, which, therefore, should be reduced by 
the credit. 

If it happens that the rent is due, and through shortage of cash, or 
otherwise, it is not paid in cash, the condition can be shown by charging 


ZS 


the expense account, Rent, as before, and crediting the person or con- 
cern to whom the rent is payable, thus: 


On) EV Ee ICV INGE. ce cca. 


for an expense is incurred which has not been met, and for which a cor- 
responding liability should be shown. 
If, later, David Brown is paid in cash the amount due him, the entry 


would be: 3 
PTE) ic ES SCD IN hae hee eee ce Yo RS 


On Acres Cite Chie Meee ES EGP whee 


for the liability, as shown in the account payable, is extinguished by the 
turning over of an asset. 

The final net result of the David Brown rent transaction is a charge 
to Rent and a credit to Cash, as in the first illustration. 


Discount 


Discount is the abatement of a portion of a sum due or to become 
due. 

Many classes of merchandise are sold on credit, that is, without 
cash payment, to persons with established financial standing, the time 
usually allowed being ten, thirty or sometimes sixty days. In such cases 
it is customary to allow a discount, or deduction, from the selling price 
in order to induce cash payments. 

For example, if a bill of merchandise is bought for $1,000, terms 
net thirty days or one per cent. discount for cash, it can be settled by a 
cash payment of $990. 

-The term discount is also applied to the rate per cent. deducted 
from the face value of a negotiable instrument, and is in the nature of 
interest. It is a common practice for business concerns to issue their 
notes, generally for short periods of thirty, sixty or ninety days, without 
interest, and discount them at their banks, that is, sell them for what 
they will bring, the proceeds being the face of the note less the discount. 
Another method of securing cash is to endorse and discount bills or notes 
which have been received from customers, the discounting bank collecting 
the face value when due. 

Discount deducted from such promissory notes, bills of exchange, etc., 
is computed by the method known as Bank Discount, that is, simple 
interest at the agreed rate of discount on the face of the bill for the time 
it has to run between the date of discount and maturity, counting the 
actual days. 


24 


Thus, the discount at 6 per cent. on a note for $1,000, maturing in 
thirty days, would be $5, and the proceeds or net cash to the one who dis- 
counts the note would be $995. If the note bears interest, the discount is 
computed on the total of principal and interest due on the note at maturity. 

Bank Discount is the method in common use, and the courts have 
held that the term discount in an ordinary commercial document means 
a rebate of interest and not true or mathematical discount. 

True Discount is “‘that interest on a certain principal for the term 
and at the rate which, when added to its principal, gives the face of the 
note or bill discounted.’’ Thus, in the example given, the true discount 
would have been $4.9751, and the Present Worth the difference between 
$1,000 and $4.9751, or $995.0249. That is, the sum of $995.0249 and 
interest thereon at 6 per cent. for one month will amount to $1,000. 

True Discount is found by dividing the amount of the obligation by 
the amount of $1 for a given time and rate (in the above case $1.005); 
the result will be the present Worth. The difference between the Present 
Worth and amount of the obligation is True Discount. 

It will be seen that Cash Discount may be in favor of the business, 
as where a liability is settled before it is due, or it may be against the 
business, as where it is allowed to a customer for payment of an account 
before it is due; or it may be allowed to a bank for discounting a bill 
receivable or a bill payable. 

Thus, discount may be an expense or a profit, and the Discount 
Account usually contains both elements, the balance of the account show- 
ing the net result of the total Discount transactions. | 

The same principles are involved in Interest, or the compensation 
for the use of money, when it is paid or received, and the items are fre- 
quently, although not necessarily, carried in one account under the cap- 
tion Interest & Discount Account. 

In determining the entry to be made for an item of Discount, the 
question is, Is it a profit or a loss? If it is a loss, it should be charged 
to Discount, because losses are charged and appear as debit balances of 
accounts; and the person in whose favor it is allowed should be credited. 
If it is a profit it should be credited to Discount, and the person from 
whom it is received should be charged. Items of interest received are 
similarly credited. 

Trade Discount is a deduction from a list price, it being the custom 
in certain lines of business to keep a fixed list of prices, the fluctuations 
in the market prices being provided for by discounts from the list prices. 
Thus, if an article is listed at $8 a dozen, the price might be 10, 5 and 2 


aS 


off, that is, 10 per cent. off $8, leaving $7.20, 5 per cent. off $7.20, leaving 
$6.84, and 2 per cent. off $6.84, leaving $6.70, as the actual price. 

Prices sometimes depend upon the amount of business transacted 
with the particular customer, such differences in price being provided 
for by the discounts allowed from list prices. | 

Trade Discount is ordinarily not taken into the accounts, as it forms 
no part of the real price. 

Allowances may be for prompt payment, adjustment of prices or 
overcharges, etc., and are deductions usually made to secure cash settle- 
ments. They are ordinarily treated in the same manner as Discounts. 


Bills Receivable and Bills Payable 


Promissory notes, bills of exchange and checks, are ordinarily termed 
negotiable instruments. Under the New York statute the essentials of 
a negotiable instrument are as follows: 

1. It must be in writing, and signed by the maker or drawer; 

2. Must contain an unconditional promise or order to pay a sum 
certain in money; 

3. Must be payable on demand, or at a fixed or determinable future 
time; 

4. Must be payable to order or to bearer; and 

5. Where the instrument is addressed to a drawee, he must be named 
or otherwise indicated therein with reasonable certainty. 

A negotiable promissory note is a written promise to pay to bearer 
or to order, for value received, a certain sum of money at a determinable 
future date. A bill of exchange, ordinarily called bill, is a written order 
of a person, called the drawer, upon a second person, called the drawee, 
to pay to bearer, or to the order of a third person called the payee, a 
certain sum of money at sight or at a determinable future date. 

In Accounting, notes and bills, when they are due to the undertaking, 
are known as bills receivable, and when payable by the undertaking, are 
known as bills payable. 

Checks, while they are negotiable instruments, are ordinarily treated 
as cash. 

Settlement of liabilities is usually made by cash or by giving notes 
or bills. If settlement is made by cash, the creditor is debited and Cash 
credited. If settlement is made by bill, the creditor is debited and an 
account called Bills Payable is credited. 

If the settlement is by cash, it is the extinction of a liability by turn- 
ing over an asset of equal value, and hence, the liability is charged and 


26 


the asset credited. If a bill is given for the liability, it is but a change 
of the form of the liability from an open account to a formal written obli- 
gation to pay, and hence takes the form of extinguishing one liability by 
a charge and raising another liability account to take its place. 

Bills Payable Account, being a liability, appears with a credit balance. 

If a bill is issued with a view of obtaining cash, instead of the settle- 
ment of an open account, the ordinary method is to make a note for a 
certain amount, due at a future date, without interest. Such notes are 
usually discounted by a bank, the amount of cash received being debited, 
and the amount of discount, which is in the nature of interest paid in 
advance, is debited, and Bills Payable credited to balance, thus: 


When the bill is paid, Bills Payable Account is debited, and Cash is 
credited, for it is the extinction of a lability by turning over an asset. 

If the bill is not paid, but renewed by a new bill, Bills Payable is 
debited, and Bills Payable is credited, so that the settlement of the prior 
note and the issue of the new one will appear in the Bills Payable Account. 
Discount is charged and Cash credited for amount of discount on new note. 

In the same manner, customers of the undertaking may make a 
settlement of their accounts in cash or by bill, and the procedure is to 
debit cash or Bills Receivable, as the case may be, and credit the account 
of the customer. Even when the sale to a customer, and the receipt of 
the bill receivable from him, are simultaneous, it is the best practice first 
to debit his account with the amount of sale, crediting Merchandise, 
and then pass another entry charging Bills Receivable and crediting 
the customer. In this way the ledger account with the customer discloses 
all of the transactions with him. 

Bills Receivable Account, being an asset, appears in the accounts 
with a debit balance. 

The bills are held in the Bills Receivable account until paid, when 
Cash is debited and Bills Receivable credited; or, until the bills are dis- 
counted, that is, the right to collect the face of the bill at maturity sold 
to the bank for whatever price in cash such right will bring. In case the 
note is discounted, Cash is charged with the proceeds, and the amount 
of discount is charged to Discount Account, crediting Bills Receivable 
Account. 

If a bill receivable is discounted and afterwards is dishonored, that 
is, not paid by the maker when due, it will come back to the business 


27 


for payment, inasmuch as it would under ordinary circumstances be 
endorsed. When such dishonored note is taken up Cash should be cred- 
ited, if paid in cash, and the party from whom it was originally received 
is charged with the amount. 

Dishonored bills should not be held in the Bills Receivable Account, 
but should be charged back to the party from whom they were received. 


Distinctions Between Expenditures 


An expenditure for rent represents nothing but loss at the end of 
an accounting period, if no payments have been made in advance. An 
expenditure upon office furniture would represent, at the end of the ac- 
counting period, value nearly equal to the expenditure. 

The rent, being a necessary expense incurred in obtaining the gross . 
profit for the period, should, in determining the net profit for the period, 
be closed out against such gross profit. 

If the office furniture is worth less to the business, by reason of use 
or otherwise, than its cost, such depreciation, being a loss incurred in 
making the gross profit, is chargeable against it the same as a direct 
expense. 

It is necessary that these distinctions be kept in mind in distributing 
charges between Real and Nominal accounts, as the soundness of the 
accounting conclusions as to profit and loss are dependent upon distin- 
guishing and charging against gross profit all the losses incurred in making 
such profit. 










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_ THEORY AND PRACTICE OF ACCOUNTS 
ie. ie APPLIED ECONOMICS AND ORGANIZATION 


(By TOMER ST. CLAIR PACE, -C. PA. (N.¥.) 


LECTURE III 


CLOSING THE BOOKS 
Pree se itech any CC Mr aman SO UN selias | 28 
PURTAL, BALANCE. 3 yc ceh PE ROR SAO ncmn Ot eR UR OT ae 28 
Pid Botner Books ee a ee 30 
=CLOSING THE NOMINAL ACCOUNTS... 065.8) 31 
TE DRAWALS SS an ON oct: ft Ca a: 34 


ASSET AND: LIABILITY ELEMENTS IN NOMINAL 


Be COOU MES COD mehr nc lal aie plea as aint ete eels 34 
Olin, Usn or NOMINAL. ACCOUNTS ons Se 35 
Post-CLosING Tee RANCH oe No ets So 
 Barance SHEET...... Tee eke A Gee gs! eh ie Oy 36 
TRADING ACCOUNT. e254. UE eee tian are pie Ty tree Ned 38 


Prorit & Loss ACCOUNT FOR SUBMISSION WITH 
RL ERN CES OHDET Oo OR hee Sy Oe Ree S 40 


COPYRIGHT, 1915, BY 
HOMER ST. CLAIR PACE 


eo PACES PACE 


PACE STANDARDIZED COURSES IN AGCOUNTANCY, BUSINESS ADMINISTRATION, 
AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


30 CHURCH STREET, | | NEW YORK CITY 





"TuHeory AND Practice or ACCOUNTS 
APPLIED ECONOMICS AND ORGANIZATION 


PemoNv eR ST CUATR PACE. CP. A. .(N. Y.) 
LECTURE III 


CLOSING THE BOOKS 


Rests 


Among the fundamental requirements of an adequate accounting 
system as stated in Lecture I, there must be rests, or times at which the 
accounting record momentarily ceases. At such time of rest the financial 
position of the undertaking is ascertained and compared with former posi- 
tions, and the intervening record is analyzed and studied with a view of 
increasing desirable and decreasing or eliminating undesirable results. 

At the close of the accounting period, in order to attain the desired 
results, the process known as closing the books is carried out, although 
the expression, in its ordinary sense, does not mean a literal closing of 
all accounts in the books, but only a closing of the Nominal accounts 
that have been raised during the transactions of the period. It was 
formerly the practice actually to close out all accounts at the time of 
such rest, but this is no longer done, at least not by American and British 
accountants. 

The process is a closing of the Nominal accounts into an account 
which is raised in the Ledger under the caption of Profit & Loss, and 
which is designed to show on the one hand, credit, the profits for the period, 
and on the other hand, debit, the expenses and losses for the period, the 
difference between the two, or balance, being the net profit or loss. | 


Trial Balance 


The initial step in closing the books is to test the accuracy of the 
postings and obtain a comprehensive view of the Ledger accounts. This 


is accomplished by the preparation of a Trial Balance. 
Copyright, 1915, by Homer St. Clair Pace. 


29 


A Trial Balance is a schedule of the Ledger accounts, showing the 
debit or credit balance of each account, the balances being arranged in 
parallel debit and credit columns and effecting an equilibrium. 

If the double entry principle is followed throughout in the entries 
and postings, and the balances of all the accounts are correctly abstracted 
and carried into the Trial Balance, the footings of the debit and credit 
columns will be the same, that is, they will balance. 

Hence, the name, Trial Balance, meaning a trial of the accounts to 
ascertain if they are in balance. 

A Ledger folio column is usually placed to the extreme left of the 
Trial Balance sheet to facilitate reference to the Ledger accounts. 

The following is an illustrative Trial Balance of the accounts of a 
sole trader, taken at the close of an accounting period as a preliminary 


to closing the books: 
JOHN SMITH 


Trial ._Balanc® as 304. 








Li: Dr. Cr 
1 Real Estates: fy paaciics «oss Ss dle. och yh UA eee ee ee $10,000 
3 Purniture Co Pietures ;.is ses G ciccg da ome tps eee oe eee 1,100 
10 CASI rs tee ae. PERE ee Sea ee 970 
12:4 Bond Ba Mortyages. ¢s59 5) cai-inmicd anal s Gah ge eee ee ea $2,000 
12...) Jorn omirth, Capital 20: pci ssn gies aee Fike ae 14,590 
100 ot. Jahr P.cfones: 05-25 weld Pa Se ER ee Bh bls Lae ae eee ee 580 
105 Wr. Halles. Fee 2605 aire ao uae 2 cao eskd cae a ee ee 2,410 
210-9 AS Brady 2. 56 eG Ha WeR RAL as tee We he Ace ee eee 1,840 
200 5 4 K7 South 8 (0.23 ce ia hn patents hee sie a ee eee eee 375 
208 “WrAper Bros: Sicibeiec ered. 5 korea htes esheets een ee eee 900 
212 WEA tC handler seal tes Gam poy season week Ge Oana eaten ne ee 1,340 
SUD MICTONANOISE) oe vice chy St vs a hk ede kee etna a ee eee 8,000 
320 Revit § SEs Age be uks,..8 nik Wicgs eA be Se lke & Peale 500 
Dek ATIBUTANICE Nocesg hed eye p+ pps dod Kae IRIS Oke k & hie chee in ale 55 
324 Wartame ra iG Ces EOE WS AA als Bc SPC bts eis ok Ge ee en 100 
326 elie gl Pee pa 4 we A Ee aR rn pyeee TULARC PT 5,000 
BOUT KMS Geis CL va ceca» + i> sgn be widenele oy tiie ee ee eee 4,900 
OAD Hi ATICTOGE pb ck oy Sc wisveti-s so 3 9 a OKA 6 RR DCLOae ope ee hee ee 50 
342 PRSCOUMES Sieh Se wik le Rs sess ok wate RR RES A We eae ne ee 200 


$27,455 $27,455 


Instead of the balances of the accounts, the totals of the debits and 
credits of each account are sometimes carried into the debit and credit 
columns respectively of the Trial Balance, and if the work is correct, the 
columns will balance as in the method of taking the differences, or bal- 
ances. The first method is now the more usual, and has the advantage 
of showing, in each case, the net condition of the account, rather than 
the total of each side. | 

A Trial Balance is usually taken once a month in addition to the 
Trial Balance taken at the close of the period. By this means errors may 


30 


be discovered and corrected while fresh, and the corrective work distrib- 
uted over the period instead of accumulating to be performed at the busy 
time of closing the books. In addition, the monthly Trial Balance affords 
a view of Ledger accounts which is useful in the management of the 
business. 

The Trial Balance is valuable as a test of the accuracy of the work 
in posting Journal entries. If the balance cannot be effected, it is evi- 
dence of error, which must be corrected in order to bring the books to 
a balance. 

Errors are, perhaps, most likely to occur in the preparation of the 
Trial Balance itself, through mistakes in addition and in abstracting the 
balances, or in omitting one or more Ledger accounts. 

If there is no error in this work, the postings are open to suspicion 
as a likely place for errors to have occurred, and if it transpires that they 
are correct, it may be due to the Journal entries themselves not being in 
equilibrium. 

While the attainment of a Trial Balance is not conclusive evidence 
that there are no errors, it is nevertheless strong evidence that the post- 
ings are correct, and that the balances have been properly abstracted. 

One of the rare things that may occur is a compensating error, that 
is, an error on one side that exactly offsets an error on the other side. 
Such an error, as well as one by which an item is posted to the wrong 
account, without affecting the equilibrium of the books, will remain un- 
detected so far as the balancing principle of the Trial Balance is con- 
cerned. However, the accuracy made possible by the Trial Balance check, 
characteristic as it is of Double Entry bookkeeping, quite compensates 
by its usefulness for the extra labor involved in making the entry with 
its twofold effect. 

The other function of the Trial Balance is to afford a comprehensive 
view of the accounts as they exist in the Ledger, not only at the time of 
closing the books, but from time to time as the trial balances are taken 
during the business period. 

At the time of closing the books, the Nominal accounts, brought to 
their proper amounts by adjustment entries after a careful survey of the 
business, are presented in the Trial Balance for scrutiny, and from it the 
information is obtained to formulate the Journal entries necessary to close 
the Nominal accounts into the Profit & Loss Account. 


Trial Balance Book 


In order to preserve the Trial Balances a Trial Balance Book is ordi- 
narily kept, ruled with numerous debit and credit columns so that the 


31 


balances may be inserted without rewriting the names of the accounts 
for each trial balance. The ruling is as follows: 


JAN. FEB. Mar. APR. 
L. F.| NAmeEs oF ACCOUNTS wn 




















The book is opened flat and the ruling extends over the two pages, 
affording columns for at least six months, and if an insert sheet is used 
between the pages, narrow enough not to obscure the names of accounts, 
columns for the entire year can be provided. The names of new accounts 
opened, ordinarily Personal accounts, can be added at the bottom of 
the list. 

Closing the Nominal Accounts 


As a preliminary step, an inventory or schedule of the goods on hand 
is made. It is merely a detailed list of the merchandise on hand, with 
values carried out, ordinarily, at cost prices. 

If a Merchandise Account has been maintained it will, presumably, 
stand charged with the amount of the purchases, and credited with the 
amount of the sales. If we deduct from the amount of purchases the cost 
of the goods on hand, the difference will be the cost of goods that have 
passed out of stock. 


Stating the proposition arithmetically with illustrative 
figures from the accounts of John Smith, the purchases amount 


LOS SAV STE IS. 58s Lied a A RE PS te cae $60,000 
The inventory of goods on hand, at cost, amounts to.......... 6,000 
Leaving cost of goods that have passed out of stock.......... $54,000 


{i the ‘sales amount: to, Say. i. -(%. ares oie Beant aie = eae eee 68,000 


The excess of selling over cost price, or Gross Profit, is........ $14,000 


32 


In Double Entry bookkeeping, the deduction of the amount of inven- 
tory from the cost of merchandise purchased is accomplished by crediting 
the Merchandise Account with the amount of Inventory. By the same 
entry a New Merchandise Account, or Inventory Account, is opened and 
charged with the amount of inventory, being at the moment a pure Real 
account, stating an asset value. The entry would be as follows: 





INVENTORY AS AT———........ $6,000 
Poe MER GEAND DSH iia Uris $6,000 
At this stage the Merchandise Account stands credited with the 
erly AI he en aed a eh Bs nde BU hae ty $68,000 
Beeman rie amount of inventory...) 6... alse ce eee bee 6,000 
Ee A RCTCL Se ee ce ete a ue es $74,000 


and it stands charged with the amount of purchases.......... 60,000 


the difference between the debit and credit sides of the Account 
TTT (wie OP ig Ti. 8). Agate wis Mas ead Caen 2 ae 4s, $14,000 
which is a credit balance, and the amount of Gross Profit that was ascer- 
tained by the former solution. 

The balance of the Merchandise Account at this time is purely Nomi- 
nal, measuring the Gross Profit. It should be transferred to Profit & Loss 
Account, closing the Merchandise Account, by a Journal entry, as follows: 


Riis Ce AON EE tat cs eb eth 3" 5 win ce pie! 2 $14,000 
Or eNO Sma WOSS ia. 2.5050 2% $14,000 


After the foregoing entries, the Merchandise Account, stating the pur- 
chases and sales in summary form, will appear as follows: 


MERCHANDISE ACCOUNT 


ME eCASCS 2) oss cee te ee ees POULOMMI TI] | bot aIGS asks 8 ira Tar cbc gs; $68,000 
“ Profit & Loss (Gross Profit) ... 14,000 PCRITVENLOLY LCL eer se teeta bg 6,000 


$74,000 $74,000 


The balance of the Inventory Account, or New Merchandise Account, 
representing cost of merchandise on hand at the beginning of the succeed- 
ing accounting period, should be charged against the Merchandise Account 
of such period. 

The various expenses and losses standing to the debit of Nominal 
accounts will then be debited to Profit & Loss Account and the respective 


33 


accounts credited to balance, as has been explained in Lecture II. This 
can usually be done by one consolidated entry, thus: 


PROFIT & LOSS To SUNDRIES.. $10,555 


IOPUIN Goes. ss chee wes Sine a een ee $500 
TNS URINE eres atone 55 
RSAC eae etn aan 100 
DALARIES chia cee ate ee eee 5,000 
EXPENSE es ce sheen ose ee 4,900 


The profits, other than the principal trading profit which has already 
been considered, are then credited to Profit & Loss Account and the re- 
spective Nominal accounts debited to balance. thus: 


SUNDRIES To PROFIT & LOSS.. $250 
INTEREST ces use peetmeeetoe cies $50 
DISCOUNT (eh seen ieee 200 


It is assumed in the illustrative figures that Interest and Discount 
accounts show a profit, but this, of course, is not always the case. 

After the foregoing entries have been made and posted, the Ledger 
Profit & Loss Account will appear as follows: 


PROFIT & LOSS ACCOUNT 





Ta Rentce oe ct er cke eran “.... $500 || By Merchandise (Gross Profit). ... ee 
§ 


TA LTISEIICE Fotos ik 5 cance eek ee orale ee eae ee  TLMTQEESUL Ls aka ha « Deke ane 
Py \GATEARE 7c cies te ee ere 100 © LNSODUTE no a:aans ain Sav a 200 
S. WALATIOS. coer td sigh + ope nese hee 5,000 
MUR DEDIEG (5 ied. ties inane dierme aan 4,900 
“ Balance down (Net Profit)..... 3,695 ; 
$14,250 $14,250 
By Balance... . «cist ne eine $3,695 


It is a desirable thing, in posting to the Ledger Profit & Loss Account, ~ 
to show the items of profit and loss, instead of the To Sundries and By 
Sundries, which in themselves mean but little. Thus, instead of posting 
in a lump sum the total amount of expenses and losses, the amount trans- 
ferred from each account, such as Rent, Insurance, Salaries, etc., is shown, 
and an inspection of the Ledger account will disclose the facts without 
recourse to the Journal. 

The closing of the books is sometimes effected by direct transfers of 
the balances of Nominal accounts to the Profit & Loss Account, without 
the use of Journal entries. Thus, Rent Account would receive a direct 


34 


credit for the amount chargeable against the accounting period, and a 
debit for that amount would be made in the Profit & Loss Account. The 
use of the Journal entries is the better practice. 


Withdrawals 


Drawings are ordinarily made by the proprietor from time to time, 
and should be charged to a Drawing Account or Personal Account. 
The drawings form no part of the profit and loss transactions, and therefore 
should not be taken into the Ledger Profit & Loss Account. ‘The balance, 
net profit or loss, of the Profit & Loss Account, as was explained in Lec- 
ture II, should be carried to the Drawing Account. The balance of the 
Drawing Account will then represent the net increase or decrease of Capital 
for the period, taking into account all the profits or losses and drawings, 
and should be transferred to the Capital Account, increasing or decreasing 
that Account just as the net investment is increased or decreased. 

In the illustrative case under consideration, there being no drawings 
by the proprietor, the Net Profit is carried directly to the Capital Account, 
by an entry as follows: 


PCat lr Cee le C2, see tee oid dene tie eo $3,695 
TO CAe ia ACCOUNT So. .', $3,695 


The books will then disclose, as at the time of opening, assets to the 
debit of accounts and liabilities and Capital to the credit of accounts. 


Asset and Liability Elements in Nominal Accounts 


Great care should be exercised in closing Nominal accounts, as it is 
evident that, in order to arrive at the true profit, only the expenses which 
belong to the accounting period should be charged and only the profits 
which belong to the accounting period should be credited. 

The expense accounts appearing in the ante-closing Trial Balance . 
may show more or less charged than rightfully belongs to the period, so 
that a careful scrutiny and adjustment are necessary. 

If insurance, for instance, is paid during the period for a three-years’ 
term, the entire amount will doubtless appear charged to the Insurance 
Account, although at the time of closing the books only that part which is 
paid for insurance for the current accounting period should be charged as 
an expense of that period. The balance, being insurance paid in advance, 
at this time should be treated as an asset of the business, and not as an 
expense. 

The simplest way to treat such an account is to charge Profit & Loss 
Account with the amount chargeable for the period and credit the amount 


a 


to Insurance Account, bringing down the balance of the Insurance Account, 
as a debit which would remain in the accounts. 

The opposite condition would exist in the case of rent which was 
accrued but not paid, and possibly not due. In such a case Profit & Loss 
Account should be charged with the full amount of rent chargeable against 
the profits of the period, and Rent Account credited. The latter would 
then show a credit balance, measuring the liability on account of rent. 
The account should then be ruled off and the balance brought down. 

There are other methods of treating such accounts. One is to close 
the old account entirely and bring down the balance in a new account, as, 
for instance, Insurance, New Account, and allow it to remain as a balance. 
This is practically the same as the first method outlined. 

Another plan is to open an account called Suspense Account and 
carry to it the debit and credit items, the balance being the net asset or 
liability. Upon entering the next accounting period the items are dis- 
tributed to their proper accounts and the Suspense Account closed, by 
entries directly the inverse of those by which the account was created. 

A Suspense Account is one raised to hold temporarily that which 
properly belongs to another account, so it will be seen that the use of a Sus- 
pense Account in this case conforms to the general use of such an account. 

The method used is not so important, so long as the principle of 
charging to an accounting period all the expenses and crediting to it all 
the profits which properly belong to it, is rigidly followed. 

It is not sufficient, in actual work, to rely upon the accounts that 
appear in the Ledger, but a critical survey of the business itself must be 
made to ascertain whether there are any outstanding assets, liabilities 
expenses, losses or profits which should be brought into the accounts to 
arrive at the real results. In the illustrative accounts of John Smith, it is 
assumed that: the accounts as presented in the Trial Balance stand at 
their proper amounts. 


The Use of Nominal Accounts 


It should be recalled at this time that the same result, or effect upon 
Capital, would have been produced by charging every expense and draw- 
ing and crediting every profit, directly to Capital Account, and that the 
whole system of Nominal accounts is raised for the purpose of classifying 
expenses and profits so that the relation of each class to the ultimate 
result may be appreciated. 


Post-Closing Trial Balance. 
A new Trial Balance should be taken after the final result is carried 
to Capital Account, to test the accuracy of the closing entries and postings, 


36 


and to display Ledger facts in such a way that they will be available for 
the preparation of later statements. 

It will appear from such post-closing Trial Balance that the Ledger 
accounts present practically the same elements as the original statement 
upon which the books were opened, viz., assets appearing as debits, lia- 
bilities appearing as credits, and Capital Account, with a credit balance, 
to balance. 

Although the actual items of assets and liabilities may vary from the 
original figures and the Capital Account show a different balance, as will 
undoubtedly be the case, the elements will be the same. 

In the accounts of John Smith, heretofore considered, the Post- 
Closing Trial Balance is as follows: 


JOHN SMITH 
Post-Closing Trial Balance as at........ 








L. F Dr. Cr 
1 LS, CLEA RR Serie SSE nD LEE ARO REO AE, xo MERE ees RM dy ee $10,000 
| | aa OM De® qb kyon RAM Se 6 FpRi aA AMA is 2, AAR ark ik 1a a Ae eae ,100 
UMMM ESION Rb hee. SOS Jugs. ida: Lapbeaiels oh staal dels oo 4 970 
12 Pond RP ALINESADE CARA EN ae ta st pn Carers wre ve! dee eee $2,000 
PPO a Cl Camital io) yec cs 55 Wes wee Wem eines stile mae ea ee 18,285 
100 | John F. Jones ee gas Nei ac Fai gig ORO ED ene PAA ALE TA Tog 580 
ee MERE CEL ALE oS eee eA ee Pie's alc). e vv Sold wa gic Mecca's 6 Sue 2,410 
110 A. scores Pere ch eh at ela ase Dl sheds me Fatianlaie wiley) Escace © 1,840 
NITE ERP EALY We tC AUR Ect, RRS abies hice ok sie «a ao ais pik wie su 6 rsalece 375 
DERE UIC R Soon, andres sa abe heats fs ptkis bes ale! Ses Aad ics he ge ole da 900 
EE CRC LSTICICE Gir Urea Tun tos eicd a ee pierces hc eis oaie dq 88 1,340 
SOM OLOTY fe At Wires os es hla sae ed PUT OR ae 6,000 





$22,900 $22,900 


_ Upon the figures of the post-closing Trial Balance is based what is 
probably the most important statement in accounting—the Balance Sheet. 


Balance Sheet 


The Balance Sheet, to define it in accordance with the generally 
accepted idea among accountants, is a statement of the assets, liabilities 
and capital of an undertaking as at a certain time, prepared from facts 
recorded in double entry books of account. 

The Balance Sheet is the statement by which the financial condition 
of the business, that is, the amount and kind of its assets and liabilities, 
as recorded in the Ledger, is made comprehensible to the proprietor and 
others. It is, in short, the connecting link between the books, on the 
one hand, and the proprietor, and his bankers or others to whom he may 
desire to communicate the financial condition of his business, on the 
other hand. 


37 


The Balance Sheet, as the most important statement that can be pre- 
pared from double entry books of account, is worthy of the most careful 
consideration, but in this elementary Lecture it is impracticable to do 
more than call attention to its most important characteristics. 

The terms Financial Statement, Business Statement, Statement 
of Resources and Liabilities, Statement of Assets and Liabilities, 
etc., are sometimes used instead of the term Balance Sheet. None is so 
short as Balance Sheet, and as the term is in good standing among English- 
speaking accountants the world over, and is used by railroads, banks and 
large business institutions, no deviation from the accepted practice should 
be made by the Accountancy student. 

The term Statement of Assets and Liabilities is generally reserved 
by accountants for the statement of assets and liabilities prepared from 
single entry books, or from sources other than double entry books. 

A Balance Sheet should be headed with the name or style of the 
undertaking, and with the date at which it is made. 

In the accepted American and Continental-European form, the assets 
appear on the left side of the Balance Sheet, under the caption Assets, 
and the liabilities, including Capital, on the right side, under the caption 
Liabilities. 

The Balance Sheet being but a rearrangement of the post-closing 
Trial Balance, and not an account, the abbreviations Dr. and Cr., and 
the introductory words To and By should not be used thereon. 

In a single proprietorship or partnership it is customary to state the 
assets and liabilities in the order of their probable quickness in realiza- 
tion and liquidation respectively. In corporation Balance Sheets this 
order is ordinarily reversed, the quickest assets and liabilities appearing 
at the bottom. 

The English practice is to reverse the sides of the Balance Sheet, 
placing the liabilities on the left side and the assets on the right side. 
This practice has doubtless grown out of the Companies Act of 1862, 
which provided for this illogical form. 

The reason for the English form is not clear. The theory advanced 
in support of it is that, the statement being an account rendered to the 
proprietors, headed by the name of the undertaking, the undertaking 
should be credited with its assets and charged with its liabilities. As 
a matter of fact the Balance Sheet is not an account, but merely a re- 
arrangement of the post-closing Trial Balance. 

The Balance Sheet of John Smith, prepared upon the basis of the 
Post-closing Trial Balance which has been given, is as follows. : 


pa eam 
agin ” 


38 


JOHN SMITH 
Balance. Sheet as at........ 





Assets Inabilities 
a Pl a ei $970 || Bond & Mortgage.. “net a ae $2,000 
Accounts Receivable, as per Accounts Payable, as per 

0 wa Spgs Seite Ab Mei a EC no 4,830 Schedule. . Can ALE 2,615 

OE SS Tae ea 6,000 || John Smith, Capital. . Re: 18,285 
Poruiture & Fixtures... 0000.0... 1,100 
AMS 1 2S aia ee a 10,000 

$22,900 $22,900 








For the sake of simplicity, no provision has been made in the fore- 
going illustrations for losses that may be incurred in the realization of the 
accounts receivable, either through bad debts or discounts, nor for depre- 
ciation. Such provision could be made by charging Profit & Loss Account 
with the estimated amounts, and in each case setting up, with a credit 
balance, a reserve. Thus, a Reserve for Bad Debts could be created, 
to which uncollectable accounts could be charged. Instead of creating , 
a reserve for depreciation it is sometimes written directly off the asset 
account by a credit entry, reducing by the amount of such entry the amount 
at which the asset is carried in the books. 

In case reserves are created they should appear on the Balance Sheet 
as a deduction from the value of the particular asset for which they are 
created, and not as a balance on the liability side. 


Trading Account 

Instead of using a Merchandise Account throughout the accounting 
period, the better and more modern method is to charge purchases to a 
Purchases Account, crediting returned purchases to the same account, the 
balance showing at all times the amount of net purchases; and to credit 
sales to a Sales Account, charging returned sales to the same account, 
the balance showing at all times the amount of net sales. 

It is necessary when closing the books .at the end of the period to 


bring together the elements of opening inventory, if any, purchases, sales 
‘and closing inventory, in order to determine the gross profit which has 


been made, and which, under’the method of using a Merchandise Account, 
is shown by the credit balance of that account. 

This is accomplished by raising on the books, at the time of closing, 
a Trading Account, to which the inventory at the commencement of the 


U. OF ii. LB, 


39 


accounting period, if any, is charged, and to which the subsequent pur- 
chases are charged, the opening inventory account and the Purchases 
Account being credited to balance, thus: 


and by crediting the amount of Sales and closing inventory, closing the 
Sales Account by a charge to balance, and setting up the inventory at 
closing, thus: 


At this stage the Trading Account will contain, in summarized form, 
all of the elements of a properly kept Merchandise Account, including a 
credit on account of closing inventory, and will show the Gross Profit 
which may have been made, by a credit balance. 

The balance of the Trading Account, showing Gross Profit, is trans- 
ferred to Profit & Loss Account, thus: 


TRADING ACCOUNT Siler tie oe eer nee 
To -PROBTTALOSS.25 i: Bae eee 


and the subsequent procedure of collecting in the Profit & Loss Account 
the items of profit and loss which are necessary to determine Net Profit 
is the same as if the balance of Gross Profit had been transferred from 
a Merchandise Account. 

If the business is large enough to justify it, a special account may be 
kept for returned purchases, instead of crediting them to the Purchases 
Account; and likewise a special account may be kept for returned sales 
instead of debiting them to the Sales Account. Where these divisions 
are made, the balance of the Returned Purchases Account is brought 
into the Trading Account, thus: 


RETURNED PURCHASES ACCOUNT.. 
To TRADING ACCOUNT sec eeanees 


and the balance of the Returned Sales Account is brought into the Trad- 
ing Account, thus: 


RAD INGUACCOUN TT cigar ier teeeerens. 
To RETURNED SALES ACCOUNT.. 


thus bringing iato the account the same elements as in the illustration 
where the division into special returns accounts was not made. 


40 


It is important to remember that the Trading Account is not main- 
tained throughout the accounting period, but is raised only at the time of 
closing to collect the elements which are necessary to determine the Gross 
Profit, and to show by the balance of the account the amount of such 
Gross Profit, and that it is immediately closed by a transfer of its balance 
to the Profit & Loss Account. 


Profit and Loss Account for Submission with Balance Sheet 


The two main purposes for which accounts are kept being the deter- 
mination of assets and liabilities, and the determination of profits and 
losses, it is necessary that there should be statements prepared from the 
books of account which disclose these facts, for the information of the 
proprietors or others in interest. 

The Balance Sheet, which has been described, displaying the assets, 
liabilities and capital as at a particular time, meets the first requirement. 

The Profit & Loss Account, as transcribed from the Ledger Profit 
& Loss Account, including explanatory detail, showing the Gross Profit 
made for a certain period of time, with the expenses and losses charge- 
able against such Gross Profit, and the resultant Net Profit, meets the 
second requirement. 

It is therefore apparent that a Profit & Loss Account may be either 
the Ledger Account raised under that caption, or the transcript of such 
account which is prepared for submission with the Balance Sheet, and 
which may vary somewhat in detail from the Ledger Account. 

If a Merchandise Account is used in the accounts, the balance, show- 
ing Gross Profit, appears as a credit to the Profit & Loss Account. 

If the division into Purchases and Sales Accounts is made in the 
accounts it is necessary to set up in the Ledger a Trading Account to 
determine Gross Profit. 

In preparing a Profit & Loss Account for submission with the Balance 
Sheet, if the Merchandise Account is used, the Gross Profit appears as a 
credit balance. If a Trading Account is used, it is usual to submit it with 
the Profit & Loss Account proper, to show the items which go to make up 
the Gross Profit. In some cases it is included as a first division in a state- 
ment called Profit & Loss Account, or Trading and Profit & Loss 
Account, the balance, Gross Profit, being brought down to the second 
division of the Account. 

The usual condition of a Gross Profit has been assumed throughout; 
although a loss upon trading is a possibility. It would not affect the 
handling of the Trading Account in any way. 


41 


In displaying such a Trading Account for submission with the Balance 
Sheet, it is the practice of American accountants to deduct the Inventory 
from the Purchases, by subtraction on the left side of the statement, 
instead of making the deduction by a credit entry as is done in the Ledger 
account. This is done in order to show, without a calculation on the 
part of the reader, the cost price, and to display such cost price in com- 
parison with the selling price. 

The Profit & Loss Account discloses the transactions that have led 
up to, and resulted in, the condition of assets and liabilities as shown 
in the Balance Sheet. In connection with drawings and contributions, 
if any, it connects the position as to capital disclosed in the Balance Sheet, 
with the position as to capital disclosed in the preceding Balance Sheet. 
It is this general idea of the purpose and use of the Profit & Loss Account 
which the student should acquire at this stage, leaving the details until 
later. 








oy 


ey 


] 








_ THEORY AND PRACTICE OF ACCOUNTS. 
| APPLIED ECONOMICS AND ORGANIZATION. 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


LECTURE IV, 


THE CASH BOOK. 


SCOPE OF THE JOURNAL AND THE LEDGER.............. 42 
Direct Enrry to Lepcer Casu Account.........5... 42 


Pere AGH OOK ne es ln) hay are a ar 43 
COCUMNAR LDIEVELOPMENT. 0008.5. dew Getik bee cate AS 
PEPOOUN Tae Cutt ea ONCE Sie Wa ierane a Sey 8 46 
ILLUSTRATIVE Case Book Eero HPO RAUIACE Nc Rav ite Pun Re Alaa 48 
LABOR-GAVING PRINCIPLES) 2.0 C2 Ok Ae Daou ae pene 
LEDGER SuMMarRY CASH ACCOUNT......0. 00.000 00004 49 - 
Perty Cages: 00s De Mae OSS a 50 
PMpansT OVSTEM Ou hie he yee ee ok 50 
- Bank ACCOUNTS AND RECONCILIATION OF CasH........ S| 
aN “STATEMENT OF RECEIPTS AND PAYMENTS.........--5- Yee e 


_ STATEMENT OF INCOME AND EXPENDITURE........2....-. 52 


« COPYRIGHT, 1914, BY 
HoMER ST. CLAIR PACE. 


PACE '& PACE 


- PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
AND ENGLISH, IN RESIDENCE AND. BY EXTENSION 


aut 30 CHURCH STREEET, ark : : AS NEW YORK CITY 





THEORY AND. PRACTICE OF ACCOUNTS 
APPLIED ECONOMICS AND ORGANIZATION 


Doerr ern 5 be CLALRY BACH] CurPiaAs (Ni Y2) 
LECTURE IV. 
THE CASH BOOK. 


Scope of the Journal and the Ledger. 


The student no doubt has observed that complete double entry books 
may be maintained by the use of the Journal and the Ledger; that ac- 
counts may be opened, maintained for a business period, and closed for 
the determination of profit and loss, with no other books than Journal 
and Ledger necessary to record every transaction. 

The Journal and the Ledger are the essential books of double entry 
bookkeeping. It is true, however, that many other books are in common 
use.~ Such books, upon investigation, are found to be but forms of the 
two basic books, calculated to economize effort in the recording of trans- 
actions, while retaining the accuracy and other desirable features of 
double entry. 


Direct Entry to Ledger Cash Account. 


It will be recalled that, in Lecture I, it was stated that a complete 
record of business transactions could be maintained on the Double Entry 
basis in the Ledger alone, but, for reasons given, that such a method would 
be impracticable. Consider, for the moment, that such an abbreviated 
procedure is used for cash transactions, entries being made directly in 
the Cash Account in the Ledger, without the use of a Journal. 

It is evident that the debits, on account of cash receipts, may be 
entered directly in the Cash Account, and that the customary Ledger 
explanation, giving the name of the account receiving credit, may be 
utilized as a guide to the proper account to be credited. 

On the other hand, cash disbursements may be entered from the 
stub of the check book directly to the credit of the Cash Account, and 
Copyright, 1914, by Homer St. Clair Pace. 


43 


the balancing charges made to the proper Ledger accounts from such 
credit Cash Account entries. 


The procedure will be apparent from the illustration which follows: 


LEDGER CASH ACCOUNT. 


1902 1902 
Jan. | 2 | To John Smith, Cap- Jans: 2 1 By. Expense. 4.3. aces $50 
ital Acct {ies $1,000 2... $84 Purchases: 25 300 
3 | “ A.B. Childs & Co. 200 4.) *" Jones’ © Cova 100 


It must be borne in mind, in such an assumed case, that entries 
would first be made in the Ledger Cash Account, balancing postings 
being made therefrom in accordance with the explanatory detail. Thus, 
to balance the initial debit entry of $1,000, that amount is credited to 
John Smith, Capital Account. 

Such a procedure amounts to an elimination of the Journal so far as 
Cash transactions are concerned. The chronological order is preserved, 
however, so that the Cash transactions may be viewed in the order of 
their occurrence. 

The foregoing method of direct entry in a Ledger Cash Account is 
rare in practice, and it is given in order to make clear the development 
and principles of the Cash Book. 


The Cash Book. 


The ordinary Ledger ruling does not afford space for sufficient ex- 
planatory detail, and for this reason, and for other reasons which will 
appear later, the Cash Account is taken bodily out of the Ledger and 
bound into a separate book; and instead of a single page containing debit 
and credit columns, a page is given to debits, and a page to credits, the 
pages being placed in opposition. 

Such a Cash Account, bound in a separate book, in which cash trans- 
actions are recorded directly and postings are made to Ledger accounts to 
balance, is known as a Cash Book. 


Find the Cash Book where you may, it amounts in principle, whether 
in.its simplest form, or with intricate columnar rulings, to the same thing— 


44 


a transposed Cash Account, given the dignity of a distinct binding, in 

which Cash transactions are entered in the first place, and from which 

balancing postings are made to maintain the double entry principle. 
The following ruling illustrates the simplest form of Cash Book: 


Dr. CASH. | January, 1902. 
Date. Accounts to be Credited. Explanatory Detail. |L.F.| Amounts. 
1902 
Jan. | 2 | To John Smith, Capital Account........ Tavestinent: nites lh ok $1,000 
Peer ert hhds Or (0.48 eh Bs plain pees Gi doeG 5 eee ie 75 200 
$1,200 
CASH. January, 1902. Cr. 
Date. Accounts to be Debited. Explanatory Detail. {L.F.| Amounts. 
1902 
Nene EY Expenses oe. Le Ve cee: Dries tae os eee oe 40 $50 
PRE ULC TAGS o-oo ie ala) SY sic terecalley oe 10 bbls. X @ $30....... 30 300 
Seem OPS Ge CO 8 2 red © peed pos OMACCE eae ke cs van ae 90 100 
REELS OCG AOTOOTG 22 1s ie dhe ods eBid pet oe aga ety ey BOW es ho e 750 
$1,200 


The pages are thus seen to be opposite to each other. The Dr., or 
receipts, page discloses the total cash receipts; and the Cr., or payments, 
page discloses the total payments, the excess of receipts over payments 
being the balance of cash on hand. 

The initial debit entry is posted to the credit of John Smith, Capital 
Account, the ledger folio being inserted in the column provided for that 
purpose. The amount of the second entry is credited to the account of 
A. B. Childs & Co. On the credit page the inverse procedure is followed 
for the various accounts indicated are debited. 

It will be seen from the foregoing explanation that the procedure, in 
theory, is the same as in the case of direct entry in the Ledger Cash Ac- 
count, and that the Cash Book amounts merely to an amplified Ledger 
Cash Account, in which the original entries are made. 


45 


When either the Dr. or the Cr. page is written full, the balance, 
usually a debit excess, is determined. In case of a debit excess, the 
amount is entered in red ink as Balance Forward on the credit page, 
and the pages are thus brought to an exact balance, which permits ruling 
off. On the new Dr. page the balance is shown as Balance Forward 
in black ink. 

Another procedure is to carry forward total receipts and total pay- 
ments, instead of the balance. This method has the advantage of dis- 
closing, by column totals, the total cash receipts, including opening cash 
balance, and the total cash payments, from the beginning of the month 
to any later date in the month. If balances were carried forward, to 
obtain this information it would be necessary to add the totals of the 
pages. 

In the rare case of excess of payments over receipts, which may occur 
through an overdraft on a bank account, the balance will be a credit 
excess, and will constitute a lability instead of an asset. 


Columnar Development. 


The saving of effort accomplished by the use of the Cash Book as 
outlined, lies principally in the elimination of the Journal by making 
debits and credits directly in the Cash Book. 

There is another avenue open for the economizing of effort—by the 
use of the principle which is expressed tersely in the axiom the whole 
equals the sum of the parts. 

In the use of the Cash Book in practice it will be noticed that there 
are recurring items of disbursements, such as rent, salaries, postage, tele- 
graph tolls, etc., which may all, or nearly all, be charged to an Expense 
Account. 

To economize effort in posting, an inner column is provided on the 
credit side of the Cash Book, to which the Expense items are carried 
during the month; and at the end of the month the column is totaled 
and carried into the regular outside column, from which it is posted to 
the debit of Expense Account. | 

Thus, the labor involved in posting to an account that would ordi- 
narily have more charges than any other account is reduced to the post- 
ing of one entry a month. 

On the debit side of the Cash Book, the receipts on account of cash 
sales are apt to be numerous, and may be collected advantageously in 
a separate column of the Cash Book of the ordinary mercantile business. 
The cash purchases, which appear on the credit side of the Cash Book, 
ordinarily, on account of their rarity, do not call for a separate column. 


46 


A column, therefore, is provided for Cash Sales on the inside of the 
regular debit column; and at the end of the month the total is carried 
to the regular debit column, and from it is posted to the credit of Mer- 
chandise Account, or, if one is maintained, Sales Account. 

It may be argued that an inspection of the Expense Account, or of 
the Sales Account, at any time other than at the close of the month’s 
business, would not disclose the true condition of the account. 

This is true, but the condition of these accounts is rarely a matter 
of interest more frequently than once a month. If it is desirable to deter- 
mine the exact condition of either account the proper procedure to fol- 
low is to add the total of the unposted amount in the Cash Book to the 
balance at the beginning of the month. 

The Cash Book is capable of indefinite expansion in this direction. 
It is practicable and desirable, in some cases, to divide the item of 
Expense into as many as ten subdivisions, with a column for each 
subdivision. 

For the successful carrying out of this method, there should be pro- 
vided on both debit and credit pages a Net Cash column, in which the 
net receipts and the net payments respectively are entered, and from 
which, by ascertaining the excess of receipts over payments, the cash 
balance may be determined. 

The use of the Expense and Cash Sales columns, as well as the Net 
Cash columns, will be illustrated after a consideration of the treatment 
of cash discounts. 

Discount. 


The question of discount frequently enters into the receipt and the 
payment of cash, not as a cash transaction, but as a concomitant, or a 
coinciding, transaction. Thus, if a business receives $99 in settlement 
of a $100 account, payable under 1 per cent. discount, the discount, while 
no part of the cash transaction, is naturally associated with the cash 
receipt, and requires accounting consideration at the same time. 

If no Cash Book were maintained, the Journal entry would be to 
debit Cash $99, debit Discount $1, and credit Debtor’s Account $100. 
If the Cash Book heretofore outlined were in use, the $99 would be carried 
into the debit side of the Cash Book, and the $1, discount would be charged 
by a Journal entry, the Debtor’s Account being credited with $99 from 
the Cash book and $1 from the Journal entry. This procedure would 
necessitate the use of two books of original entry to cover the transaction. 

Items of discount flow from, and are associated with, cash transac- 
tions. For convenience of reference and economy of effort, it is desirable 
to record such items in proximity to the cash transactions from which 


47 


they flow. Columns, therefore, are ordinarily provided in the Cash Book 
for that purpose. Thus, in the illustration given, the receipt of the $99 
is recorded in the Net Cash column on the debit side of the Cash Book; 
the $1 discount is recorded in the adjoining Discount column; and the 
total, $100, is carried to a Total column. 

The item of $100, being the amount which the cash payment of $99 
liquidates, is posted to the credit of the one who makes the payment. 
Cash is charged with the $99 by the act of entering it in the debit side 
of the Cash Book; and it remains to charge the $1, representing the expense 
or loss in securing the cash settlement, to Discount. 

It is a rule to carry postings from the debit side of the Cash Book 
to the credit of Ledger accounts, but it is evident that the effect of dis- 
playing the discount in proximity to the cash received, has been to in- 
troduce an element into the debit side of the Cash Book which must be 
placed to the debit of a Ledger account, for discount given, being an ex- 
pense, or a loss, cannot under any circumstances be credited to Discount. 

This inconsistency is allowed to remain during the progress of the 
month’s business, and the total is then carried to the credit side of the 
Cash Book in the Discount column. From there it is posted, as are all 
other items on the credit side (with the exception of discounts received), 
to the debit of the proper Ledger accounts. 

The discounts received, which present a similar inconsistency, are 
allowed to remain in the Discount column on the credit side of the Cash 
Book during the progress of the month’s business, and the total is then 
carried to the Discount column on the debit side of the Cash Book, and 
then posted, as are all other items on the debit side (with the exception 
of discounts given), to the credit of the proper Ledger accounts. 

The carrying over is a simple matter. An entry to Discount is 
made with the explanation, Discounts given, (or received) per contra. 
After this, the postings are made as for any other Cash Book entry, as 
has been indicated. 

This procedure, which brings the postings from the Cash Book within 
the rule that Cash Book debits must be posted to the credit of Ledger 
accounts, and that Cash Book credits must be posted to the debit of 
Ledger accounts, permits of a neat balancing of the Discount columns. 

There are other methods of handling discount in the Cash Book, 
notably in the case of the use of Summary Entries in the Journal at month- 
ends. This matter will be considered fully in a later Lecture. 

It is well to note that Discount forms the exception to the rule that 
nothing but actual cash transactions shall be recorded in the Cash Book. 


48 


Illustrative Cash Book. 


The following illustration of an eight-column Cash Book makes clear 
the use of the columns which have been described: 


1902 
Jan. 


Net 
Cash. 


Dis- 


Cash 


count.| Sales. | Total. 


es ee | ee | — | 


$2,858 














Dis- 














$750 
100 
$500 
500 
300 
100 
120 
200 
200 
100 
1,220 
20 
$2,890 
Cr. 
Ex- 


count.} pense.| Total. 


| | | 


CASH. January, 1902. 
Accounts to be Explanatory 
Credited. Detail. Tak: 
LP ese e MOL WALGL. ih 1. tc clad s. ctalchastece atake 
ee ep LIN: « o4..\otlotiee< 15 Ge ee Ae. 78 
eC el Salt... coke nk 10 CoG Sout. sabe 
PA st Mnlg Ge GAY, Peal) CIA. Ow. 75 
URE RSELNCSALOLE ico kb 4 + ANG $60) ot x 
<i ED 5 Be aa aes | EN dees Pe ar 8 
+ fh Ber SO a 2A @ $60....... ¥ 
BERD RRR 27 ee cle Fae ON. acetone. a 
BASEL oles TNS ce ah. 10 B @ $20 x 
«tO Eo he ct (er 5B @ $20 he 
OW LES. Pete se he a total, for mo..... 31 
© “Discount, %.- casi. oa: recd. per contra. .| 42 
CASH. January, 1902. 
Accounts to be Explanatory 
Debited. Detail. EF; 
ESUIPURDCNGG? coo ee aS SAIAVIOS 20 sarees oh x 
See ANTE T Ess ccna ce 2 desks @ $45...| 5 
SP IStULOG i. oat e's we as shelving......... 6 
o: EKpeie tI d oe ie okt salaries 7 ipeox. x 
mp ienres ar CO. ken AS ELE Re Cee 90 
MICE DICTISE Tes. ts BL WOstage: in cweer. 4 
S-E-XpenSe@eh4 Hes la es Salarigss » .acimertss x 
Be eri Gr COls oles. 3: Re ere ae 91 
SPPPEXPENSe iss. oS Fh eS salaresy, ofcie cya. [o.& 
pe eR IIHS. 6s et bc. cise total for mo...... 45 
SV IISCOMMGT see. bs4a.. given per contra. .| 42 


Walgnoe FOnUath. tii Ry. oso TE 




















$35 
$90 
110 

35 
500 

D 

35 
1,000 

35 
145 
12 
1,033 
$2,890 








It will be noted that in the case of items, such as Expense, which 
are posted in a monthly total, the individual item is checked or ticked, 
and the Ledger page is inserted against the amount finally carried to 
the Ledger. 


49 


The ruling of a Cash Book should depend upon the needs of the 
particular business. The foregoing example is given merely as a form 
correct in principle, which illustrates the theory covered. 


Labor-Saving Principles. 


The illustrations given make clear the two great labor-saving prin- 
ciples of the Cash Book, which are: 

1. The elimination of Journal entries for cash transactions, the trans- 
actions being entered directly in the Cash Book. 

2. The collection of similar items, in distinctive columns, to be posted 
by totals periodically. 

Any further development of the Cash Book must be along the lines 
of the second principle, by the addition of columns. 

The multiplicity of columns and volume of detail, which mark what 
are ordinarily considered complicated forms of the Cash Book, will not 
confuse the student if he keeps the two principles clearly in mind. 


Ledger Summary Cash Account. 


If the Cash Book amounts to a transposed Ledger Account, it is 
evident that, in order to arrive at a Trial Balance, the balance of cash, 
as shown by the Cash Book, must be taken into account. 

It is sometimes desirable, however, to have the Ledger complete, 
in order that a Trial Balance may be taken from it without reference to 
any other book. 

In such a case, the cash transactions are carried into a Ledger Cash 
Account at the end of the month in summary form, so that the Ledger 
Cash Account is made a summary, by months, of the Cash Book. 

This result is accomplished by posting, at the end of the month, the 
total receipts of cash, as shown by Cash Book, to the debit of the Ledger 
Cash Account, and by posting the total disbursements to the credit of 
the Ledger Cash Account. 

Or, more scientifically, Journal entries may be passed, debiting 
Ledger Cash Account and crediting Sundry Accounts for the cash re- 
ceipts. The first part of the entry is posted and a note is made that the 
Sundry Accounts have been credited directly from the Cash Book. The 
inverse procedure is carried out for cash disbursements. 

There will, by either method, appear in the Ledger an account giving 
a summary of cash transactions, to be treated as any other account is 
treated in arriving at a Trial Balance. 


50 


Petty Cash. 


All cash receipts should be deposited in bank, and all payments, 
as far as practicable, should be made by check. 

It is usually found necessary to have available a small amount of 
actual cash to meet expenditures for telegrams, postage, car-fare, etc. 
Such a fund is known as Petty Cash. 

A common, but unsatisfactory, method of handling Petty Cash, is 
to furnish the cashier, or other person handling the fund, with a small 
amount of cash, say $25, charging Expense and crediting Cash. When 
the money is expended, another amount is furnished, and so on. 

If any expenditure is made from Petty Cash other than one charge- 
able to Expense, a corrective entry must be passed. For example, if furni- 
ture were bought, Furniture & Fixtures would be debited and Expense 
would be credited. 

By this method corrective entries are necessary, and the Cash Book 
entry for the amount turned over to the cashier does not show the actual 
items of expenditure. If small cash receipts are not deposited, but taken 
into the Petty Cash fund, a Journal entry charging Expense and credit- 
ing sales or a personal account is necessary; and the situation is further 
complicated. 


Imprest System. 


A better method, known as the Imprest system, is to draw a check 
to the cashier for an amount estimated to be sufficient to cover the Petty 
Cash expenditures for a certain period, say a week, two weeks or a month, 
and to open a Ledger account in the name of the petty cashier, the amount 
so advanced being charged, and Cash being credited. 

At the end of the week, or other agreed period, the petty cashier 
presents an itemized statement of his Petty Cash disbursements, and a 
check is drawn for the exact amount and turned over to him in payment. 
An entry is made on the credit side of the Cash Book, the same as for 
any other disbursement, with the proper account, usually Expense, charged, 
with explanatory detail as to division between car-fare, postage, tele- 
Prams, etc. 

This procedure restores the Petty Cash fund in the hands of the 
cashier to its original amount, and the same procedure is followed for 
the next period. 

The original amount stands charged to the cashier in the Ledger 
account, and no entry is made therein until the final settlement and relin- 
quishment by the cashier of the fund. He then renders his final statement 
and turns over the balance of cash. Entries are made charging Cash 


51 


for the amount of cash turned over, charging the proper accounts for the 
disbursements, and crediting the Cashier’s ledger account to balance. 

A Petty Cash book may be used, showing, upon the one hand, the 
receipts, and, upon the other hand, the disbursements, the latter in columns 
ruled to show division of expenditures for car-fare, postage, telegrams, 
etc. The totals of these distribution columns will be the total amount 
of expenditures for which check will be received. The totals of such 
columns furnish the items for the periodical statements. 

Another method is to keep a running account of expenditures, to 
classify the expenditures in the bill rendered, to attach all vouchers which 
have been obtained, to have the whole approved, and to file. 

No part of the cash receipts of a business should be placed, in the 
first instance, in Petty Cash. Cash receipts, no matter how small, should 
be deposited in the bank account. 


Bank Accounts and Reconciliation of Cash. 


The ordinary procedure of handling cash funds, viz., that of deposit- 
ing cash in a bank or trust company account, and making payments by 
checks against such account, has been assumed throughout. 

In this case, the net balance of cash as shown by the Cash Book, 
is the amount by which the total amount of deposits exceeds the total 
amount of checks drawn. 

The bank furnishes what is known as a Pass Book, in which the 
total amount of each deposit is entered as made. The Pass Book should 
be left with the bank at the close of each month’s business to be balanced. 
The bank adds the deposits, entering any that may have been omitted 
by failure to present Pass Book when making deposits, lists the paid checks 
chargeable to the account, and deducts their amount from the amount 
deposited, and thus shows the resulting cash balance. The paid checks, 
with adding machine list thereof, are returned to the depositor with the 
balanced Pass Book. 

Such Pass Book balance may not agree with the Cash Book balance, 
for the reason that there may be checks which have been issued, but 
which have not been presented to the bank for payment. 

Checks are usually numbered, and by arranging the paid checks in 
their numerical order, the outstanding ones are easily ascertained. 

The amount of such outstanding checks deducted from the balance 
as shown by the Pass Book should give an amount which is exactly equal 
to the balance as shown by the Cash Book. If there are charges for col- 
lection of out-of-town items, or interest credits, they must be taken into 
account, and Cash Book entries passed to cover. | 


52 


This procedure is called a reconciliation of Cash. 

Instead of one bank account, two or more may be maintained. Usually 
no attempt is made to show the division of deposits and checks between 
different banks in the Cash Book, but the balances shown by the stubs 
in the check books, should equal, in the aggregate, the total cash balance 
shown in the Cash Book. The reconciliation with the banks is carried 
out in the manner before given. 


Statement of Receipts and Payments. 


A Statement of Receipts and Payments, or as it is sometimes known, 
a Statement of Receipts and Disbursements, is one showing the cash 
receipts and cash payments of a concern for a certain period of time. 

A Statement of Receipts and Payments is made in the form of a 
cash account, the receipts being placed on the debit side under the cap- 
tion Receipts, and the payments on the credit side under the caption 
Payments. 

The cash receipts and payments of a concern do not ordinarily dis- 
close the profits for the period covered, for part of the profits may be 
represented by Accounts Receivable or by other assets which are not 
converted into cash. In addition, there may be contributions of capital, 
or the purchase or disposition of assets, all of which, being cash trans- 
actions, will be shown in a Statement of Receipts and Payments, but 
which do not necessarily affect the profit or earnings. 


Statement of Income and Expenditure. 


A Statement of Income and Expenditure, sometimes known as a 
Statement of Revenue and Expenditure, or merely as a Revenue Account, 
is a Statement of the income of an undertaking which properly belongs 
to a certain period of time, whether actually received in cash or not, and 
of the charges which are properly an offset to such income, whether actu- 
ally paid or not. 

A Statement of Income and Expenditure is made in the form of a 
Profit and Loss Account, and will contain the same elements, income 
appearing on the credit side under the caption Income, and expendi- 
ture on the debit side under the caption Expenditure. 

To illustrate the difference between a Statement of Receipts and 
Payments, and a Statement of Income and Expenditure, the case of 
rent may be cited. An undertaking might pay its rent for the ten months 
ending with October, and owe for the two months November and Decem- 
ber. In preparing a Statement of Income and Expenditure (that is, a 
profit and loss account) for the year ending December 31st, it would be 


53 


necessary to charge against such statement rent for the entire twelve 
months, and set up in the accounts a liability for the two months’ rent, 
inasmuch as the rent was a necessary expense incurred in making the 
profit. | 

If a Statement of Receipts and Payments were being made up for 
the same period, the actual cash paid out, which would cover only the 
ten months’ rent, would be carried in, the other two months, of course, 
not appearing in the Statement. 

The foregoing statements are not Ledger accounts, but are state- 
ments prepared from the books for the proprietor or for others who may 
require the information. They may cover several years in time, or only 
a part of a regular accounting period, as the case may require. 

The distinction between these two statements must be thoroughly 
understood and kept in mind, for the principles involved are far-reaching 
in effect. 





kh 
y) 
we 
ry 





THEORY AND PRACTICE OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


_ By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


LECTURE V. 


SINGLE ENTRY BOOKKEEPING. 


POORER PING UN ue Oe TAC aie a ara 54 
| SINGLE ENTRY BOOKKEEPINGY : 4. 320 fel BE? ORE Nae a a tac 
Books AND PROCEDURE IN SINGLE ENTRY........ aie eS 
STATEMENT OF ASSETS AND DIABILIMIES ee oes a 58 


‘DETERMINATION OF PRrorit AND Loss 1N SINGLE Entry. 59 
COMPARISON OF SINGLE ENTRY WITH DOUBLE EnTRY... 61 
UNDERLYING ‘PRINCIPLES OF THE Prorit & Loss Ac- 


« 


COUNT... EL Sa Sa OREO HUES att ay ane EC AA ane RN ag 63 


CopyriGHT, 1914, By 
HOMER ST. CLAIR ‘PACER. 


PACE & PACE 


PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
+ ' AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


~ 30 CHURCH STREET, | - NEW YORK CITY 





THEORY AND PRacTICE OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE V. 
SINGLE ENTRY BOOKKEEPING. 


Bookkeeping. 


Bookkeeping may be defined as the systematic and chronological 
recording of financial transactions, showing in respect to the particular 
undertaking, ownership of values, liability for values, and the acquisi- 
tion and transfer of values. 

The bookkeeping record is maintained in order to make possible at 
any time the ascertainment of the facts as to amount of assets and lia- 
bilities, and the facts as to the increase or decrease of net asset value due 
to trading or operation. 

Upon analysis, it will be found that the minor purposes for which 
the bookkeeping record is made, fall under one or the other of these two 
main objects—the determination of assets and liabilities, and the deter- 
mination of profits and losses. Thus, it may be said that the bookkeeping 
record is useful as evidence in controversies, but it is apparent that this 
function falls under the determination of assets and liabilities. 


Single Entry Bookkeeping. 
It has been pointed out that there are two methods of bookkeeping, 
WIZ. : 
Double Entry, which is the method of expressing accounting re- 
sults evolved from the doctrine of equilibrium; and 
Single Entry, which, in the broadest sense, may be said to include 
all bookkeeping devices other than Double Entry. 


Copyright, 1914. by Homer St. Clair Pace 


55 


While under the name of Single Entry may be grouped all bookkeep- 
ing methods other than Double Entry, the term Single Entry has a more 
restricted meaning, in that it is applied ordinarily to a method of book- 
keeping in which accounts with persons only are kept. These accounts 
include accounts with the proprietor, showing amount of investment, 
contributions of capital and withdrawals; and accounts with all indi- 
viduals, firms and corporations with whom the undertaking has trans- 
actions that necessitate a record in books of account. The use of Single 
Entry is now confined almost entirely to small retail concerns. 

The consideration of Single Entry, now about to be undertaken, 
will be helpful in the specific matter of converting Single Entry books 
of account to the Double Entry basis,—the connection in which Single 
Entry books most frequently come to the attention of the accountant. 
In addition the advantages of Double Entry may be shown, in comparison 
with Single Entry, more clearly than in any other manner. 

Real accounts, other than those that are personal, and Nominal 
accounts, which in Double Entry bookkeeping supply the elements neces- 
sary to effect the equilibrium, and which furnish analytical information 
useful in the conduct of the undertaking, are not maintained in Single 
Entry. 


Books and Procedure in Single Entry. 


In Single Entry, it is the custom to maintain a book of original entry, 
sometimes known as the Day Book, ruled in the usual Journal form, with 
two money columns to the right of the page. The column to the extreme 
right is reserved for amounts which are to be posted to ledger accounts. 
Both debit and credit entries, the former meaning an amount carried 
to the left of a Ledger account, and the latter an amount carried to the 
right of a Ledger account, are placed in this column, a notation being 
made against the entry, by a Dr. or Cr. abbreviation, to indicate whether 
the amount is to be posted as a debit or a credit. The inside money col- 
umn is reserved for detailed amounts. 

In opening Single Entry books, the amount of the investment is 
shown, with the details of the assets which constitute the investment. 
The investment, the amount of which is to be posted to the ledger account 
of the proprietor, is carried to the column to the extreme right, while 
the details of the assets are shown in the other money column. 

Liabilities which are an offset against the assets, may be deducted 
from the assets in the opening entry, as will be illustrated later. Another 
procedure is to credit the investment account with the total amount of 
the assets, and by a separate entry to charge the amount of the liabilities 


56 


to the investment account, the details of such liabilities being shown in 
the inside column. 

It is thus apparent that the books will be opened with an account 
in the Ledger showing the net investment. Ina partnership business, an 
investment account is opened for the agreed net asset value contributed 
by each partner. 

Under this procedure the net investment of the owner or of the respective 
partners is recorded, but the specific assets and liabilities are not recorded 
except in the case of accounts receivable or payable,—that is, accounts 
with persons. 

For example, John Smith, a sole trader, starts in business with the 
following assets and liabilities: Cash, $1,000; Merchandise, $4,000; due 
from John Doe, $1,000, and due to Richard Roe, $500. The opening 
entry would be made as follows: 


NEW YORK, January, 1902. 


. Column Column 
Ledger for for 
Folio Details Posting 
2 
JOHN SMITH, Investment Account................ Cr. $5,500.00 
For capital this day invested, details as under: 
Cash, deposited in Pracers: INavional Bank? 47). 2... .... $1,000.00 
PACE OAnCise. Av Dee INVENTOLY.. <6 as bea pc Kaeo joieiesei oo eke 4,000.00 
John Doe, account receivable......... 0... 0... e eee 1,000.00 
Pete AGUS er et 5 ed NS Th ere Ss htc ak ae Wes $6,000.00 
Less: 
Be Nariwee ACCOUNT, DAVADIC® 65 55 wad en se ecinccles kes 500.00 
Leaving Net Investment, as above................. $5,500.00 
Z 
SOPPIENCASONS oso cuis APRESS Hh 1 a ee ee ce Dr. 1,000.00 
For amount due me, as per opening entry............ $1,000.00 
Z 
Pe PETEROR, sei cc: Se LA Cr. 500.00 


For amount due him, as per opening entry............ $500.00 | - 


yi 


Two entries might have been made in the opening, crediting John Smith, 
Investment Account, with the amount of the assets, and charging him with 
the amount of the liabilities. The same net result would be thus achieved. 

The entries are posted to a Ledger, which may be ruled in Journal form, 
with two money columns to right of page, or it may be ruled in the usual 
Ledger form, and divided in the center, with debit money column to the 
left of center ruling, and credit money column to the extreme right of page. 

It is apparent that, following the foregoing procedure, when the 
books are opened, they will show all accounts with persons, including 
the person that is the proprietor; but that no accounts are opened for 
such assets as cash and merchandise. 

It is customary to maintain a Cash Book, in addition to the Day 
Book, although in many cases the record which is kept in the check book 
suffices. When a Cash Book is kept, it has the ordinary Journal ruling, 
the inside money column being reserved for opening balance and subse- 
quent receipts, and the column to the extreme right being reserved for 
payments, the difference between the two columns showing the cash balance. 

Even when a Cash Book is maintained, it is the common practice 
to enter all cash receipts and payments which affect accounts with per- 
sons, in the Day Book, as well as in the Cash Book. All postings are 
made from the Day Book, the Cash Book merely showing the cash re- 
ceipts and payments, including expense disbursements, which would not 
be posted or entered elsewhere. 

The following is a usual form of Cash Book, with illustrative entries: 


NEW YORK, January, 1902. 





Column Column Column 
for for for 
Date Receipts Payments 

2 BALANCE 4.t9ee5 as per Day -Bookyssc4is5-49 i ies $1,000.00 
3 CASH SAL Es cm ts THOSE, ci (sash ane pete eerie ee Meee .00 
. JOHN: DOE ie sa8i? bal. due (entered in Day Book).... 1,000.00 

RICHARD ROE...on acct. (entered in Day Book).... $250.00 
4 REN dee weneel st month of Jantiatyy; S275. cn we 100.00 
. EXPENSE aoe be stationery .4 uae te ewe eek Lee 18.00 
: BALANCE. 03 i585 55 Ver ON 8 CORRE Se 4 ea 1,732.00 


$2,100.00 $2,100.00 


5 BALANCE wai. coed Wiis oo ae cee ever oer aie ee $1,732.00 


58 


In the case of purchases on credit, no record is made of the merchan- 
dise received, but the concern from whom the purchase is made is cred- 
ited by a Day Book entry. Later, when payment is made, the amount is 
entered in the Cash Book, the creditor is charged by a Day Book entry, 
and the account is closed. 

Sales on credit are treated inversely. To illustrate a sales transac- 
tion: If goods amounting to $500, consisting of five items of $100 each, 
were sold to John Doe, John Doe’s name would be written in, the abbre- 
viation Dr. inserted against it, and the $500 carried to the column to 
the extreme right to be posted, while below would be given a list of the 
various items, with the amount of each carried to the inside column, 
which, totaled, would equal the $500. 


Statement of Assets and Liabilities. 


At the end of the accounting period, the financial position of the 
- undertaking, when the books are kept upon the Single Entry basis, is 
displayed by what is known as a Statement of Assets and Liabilities. 

The assets consisting of Accounts Receivable will be shown in the 
Single Entry ledger, and the balance of cash on hand can be ascertained 
from the check book or the Cash Book, and verified by counting the actual 
cash in hand and by having the bank pass book written up. An inventory 
is made of the other assets, care being taken that none is omitted, and 
that valuations are made on a conservative basis, with bad debts elimi- 
nated. These assets are collected in schedule form, under the caption 
Assets, the amount of each asset being carried to an inside column, and 
the total of this column to an outside column on the extreme right of 
the sheet. 

The various liabilities are then determined, the Accounts Payable, 
of course, appearing in the Single Entry ledger. They are then scheduled 
under the caption Liabilities, the respective amounts being carried to 
an inside column. The total of this column is carried out under the total 
amount of assets and is deducted therefrom. The balance, in a solvent 
concern, shows the net investment of the business. 

The difference between the assets and liabilities, if the amount of 
assets be the greater, is the investment. If the liabilities exceed the 
assets, the amount of such excess is the deficiency. 

The form of the Statement may vary in detail, but, as here given, 
it is usually a running schedule, with assets stated first and then liabili- 
ties, which are deducted from the assets, the difference being the investment. 

The term Statement of Assets and Liabilities is sometimes used 
to describe the statement which displays somewhat: similar facts, and 


59 


which is prepared from Double Entry books of account; but the pre- 
ferable term for the latter statement, and the one used throughout these 
lectures, is Balance Sheet. 

It is not unusual to see Balance Sheet facts displayed in the running 
form, to economize in space, although the more usual form of the Balance 
Sheet displays the facts in opposition. 


Determination of Profit and Loss in Single Entry. 


To determine the Profit & Loss (or Loss & Gain as it is sometimes 
called), for an accounting period, in an undertaking in which Single Entry 
books of account are used, it is necessary to have: 

1. The amount of the net investment at the beginning of the account- 
ing period, or a statement of all the assets and all the liabilities at the. 
beginning, in order that such net investment may be determined; 

2. Similar facts at the close of the period; 

3. The facts as to the withdrawal and contribution of capital during 
the period. 

The difference between the investment at the beginning and at the 
closing of the period will be the net increase or the net decrease in the 
investment. 

If withdrawals have been made by the proprietor, their amount 
must be added to the increase in investment, or deducted from the decrease 
in investment, in order to arrive at the net result as to profit or loss. This 
procedure is necessary, because assets, whether of cash or property, that 
are withdrawn by the proprietor for his own use, are not consumed to 
aid the business, and, therefore, are not expenses of the business. It is 
frequently the case that the investment decreases, by reason of with- 
drawals, while there is, as a matter of fact, a profit for the accounting 
period. 

Contributions of capital present a condition the inverse of with- 
drawals, for such increase in capital has not been produced by the busi- 
ness. Therefore, from the increase of the investment must be deducted 
the contributions. If, despite the contributions, the investment has 
decreased, then to the decrease must be added the contributions, in order 
to determine the loss. 

In addition to withdrawals, an amount is sometimes charged to the 
proprietor in a Salary Account. In determining the net profit, such an 
amount ordinarily should be treated the same as a withdrawal. The 
net return or profit is the aggregate which the proprietor secures by reason 
of his effort and the use of his capital. Therefore, an amount charged as 


60 


his salary is fixed arbitrarily, and is in the nature of an advance against 
the profits which are being earned. 

If there have been neither withdrawals nor contributions between the 
opening and the closing of the accounting period, if the opening invest- 
ment can be ascertained, and if the closing investment can be determined 
by deducting from the amount of the assets, correctly valued, the amount 
of the liabilities, the difference between the opening investment and the 
closing investment will be the true profit, if there be an increase, and 
the true loss, if there be a decrease. 

These facts are usually displayed in connection with the assets and 
liabilities, the investment at the opening and the closing being reconciled 
with the contributions, the withdrawals, and the profit or loss. This 
procedure is known as the Resource and Liability method of determin- 
ing profit or loss. As distinguished from the Resource and Liability 
method, the method of collecting nominal accounts in Double Entry is 
‘known as the Profit & Loss or Loss & Gain method. 

In order to illustrate the construction of the statements which have 
been described, it will be assumed that John Smith, at the end of an 
accounting period, say December 31, 1902, has assets and liabilities, as 
per his Single Entry ledger, as follows: Investment at January 2, 1902, 
$5,500; withdrawals, $1,800; Accounts Receivable, $6,000; Accounts 
Payable, $3,000. From his Cash Book it appears that he has $1,250 in 
bank, and $50 in hand for petty cash disbursements, and his Merchandise 
inventories at cost $2,500. In addition to the liabilities in the Ledger, 
he has a note outstanding for $1,000. 

It is required that a Statement of Assets and Liabilities be prepared, 
as at December 31, 1902, as well as a statement showing the results of 
trading for the year. It is desired that no allowance be made for possible 
losses in the collection of Accounts Receivable. 

Following the procedure heretofore given, the following statement is 
prepared: 


61 


JOHN SMITH. 


STATEMENT OF ASSETS AND LIABILITIES AS AT DECEMBER 31, 1902, 
DiscLosinc NET PROFIT FOR THE YEAR 1902. 


Assets. 
Gashsinthand errs ee eee $50.00 
Th Hankgiasiy. Sea ee eee 1,250.00 
—§—— $1,300.00 
Accounts Receivable: 3). bie. a eee 6,000.00 
Merchandise /onmhand Aik yaa ee ae ee 2,500.00 
‘Botal Assets i) eve Ae $9,800.00 
Liabilities. 
Aoootints Payable wa iihl os ak eee een $3,000.00 
Bills ‘Payable 355, Giusti te the Oreck 1,000.00 4,000.00 
Investment as at December 31, 1902.. $5,800.00 
Investment as at January 2, 1902.... 5,500.00 
Increase in Investment.....'....... $300.00 
Add amount of withdrawals.......... 1800.00 


Net: profit fon years cvcceie plcb dw oe $2,100.00 


Comparison of Single Entry with Double Entry. 


In viewing the Single Entry bookkeeping procedure which has been 
outlined, and the statement which it is practicable to produce therefrom, 
it is evident that, in comparison with Double Entry, Single Entry labors 
under many disadvantages. 

Considering the books of account proper, it is apparent that there 
is greater liability of error in Single Entry than in Double Entry. Thus, 
in the case of a sale of goods to a customer, if the amount, after being 
entered, is not posted to the debtor’s account, there is no automatic 
check in the books acting as a safeguard against a loss of the item. In 
Double Entry, on the contrary, a record of the amounts of sales being 
kept, it would be necessary to find and take into consideration the amount 
of every sale, in order to produce the equilibrium. 

It is also clear that in Single Entry no record is made of assets 
other than Cash and Accounts Receivable, that reliance must be had 
upon schedules and other memoranda, and that no check against over- 


62 


sight is thus provided. Thus, a security owned by a concern might easily 
be overlooked because of the death or the absence of the principal, or 
because of his poor memory. If the ownership of such an asset is recorded 
in a Double Entry ledger, its existence must be noticed in every Trial 
Balance, and the record will show either its ownership, or its disposition, 
and the reasons therefor. 

It is evident therefore that the complete record of all assets and liabil- 
ities maintained in Double Entry is a distinct advantage over the in- 
complete record maintained in Single Entry. 

It is true that there is more labor involved in the first instance in 
Double Entry than in Single Entry. This difference has been largely 
overcome in the modern development of Double Entry by the use of 
additional columns in books of original entry, by which the balancing or 
nominal elements are carried to the ledger by monthly postings, instead 
of by daily postings. This principle has already been fully explained in 
Lecture IV in its application to the Double Entry cash book. By the 
use of this principle, the work involved in Double Entry is reduced to a 
point where it is little in excess of that required by Single Entry. It in- 
sures all of the accuracy and the analytic benefits of Double Entry, with 
none of the disadvantages, but with the economy of effort, of Single Entry. 

From a study of the illustrative statements which have been given, 
it will be seen that the only information in respect to trading results 
is as to the net result for the accounting period. The reasons for the 
result, whether it be good or bad, are not apparent; and the total amount 
of business which has been transacted cannot be ascertained therefrom. 

No record or only a partial or inadequate record of expenses or losses 
or of profits being kept, the management cannot detect variations in 
particular expenses and profits, but is able to consider only the result as 
a whole after it has been accomplished. 

In Double Entry, with expenses and profits recorded and divided 
into such items as Salaries, Rent, Insurance, Taxes, Discount, and Inter- 
est, with the trading accounts of Purchases, Sales, etc., set up, and with 
the elements divided to as great an extent as the volume of business of 
the particular undertaking may justify, the status of any particular divi- 
sion may be compared with its condition at the same state of the preceding 
year’s business. Therefore, the corrective work that is found to be neces- 
sary can be applied in time to avert possible losses or to increase profits. 

Aside from the benefits to be derived throughout the accounting 
period, the analysis is particularly valuable at the close of the period 
in reviewing the entire work with a view to increasing the earning capacity 
of the undertaking during the succeeding period. 


63 


The advantages of Double Entry over Single Entry may, in view 
of the foregoing discussion, be summarized as follows: 

1. Less liability of error, through (a) automatic safeguards, and 
(b) fuller record. 

2. Analysis of profit and loss elements, obtained from the accounts 
used to effect the equilibrium, securing (a) comparison of each element 
during the accounting period, and (b) comparison in periodical statements. 


Underlying Principles of the Profit and Loss Account. 


It is useful to learn fully why the Profit & Loss Account, as prepared 
from Double Entry books of account, discloses the facts as to profit or 
loss. 

The nominal accounts, which are necessary to maintain the equi- 
librium, record the increase and the decrease of assets and liabilities. 
Considering first a nominal account recording an expense element, it 
must be the result of a reduction of an asset or the creation of a liability. 
For example, rent may be set up as a debit entry; and if it is paid by 
cash, Cash Account is credited and thereby reduced. If it is not paid, 
a liability is created and recorded by a credit entry. Hence, a nominal 
account with a debit balance measures an unfavorable effect, such as 
the reduction of an asset or the creation of a liability, upon the net asset 
value in the business. 

Inversely, a nominal account with a credit balance measures a favor- 
able effect, such as the creation of an asset or the reduction of a liability, 
upon the net asset value in the business. Thus, if merchandise that costs 
$15,000 is exchanged for $25,000, the account recording the merchandise 
may be credited with its cost, $15,000, to mark its elimination from the 
assets; and, to preserve the equilibrium, it will still be necessary to credit 
$10,000 to a nominal account, in order to measure the increase of asset 
value. The profit resulting from the extinction of a liability is rare, be- 
cause liquidation is usually effected by turning over asset value equal to 
the liability. It might occur in the case of a donation, or the settlement 
of liabilities at less than their face, but such profit differs from the trading 
profit which is being considered. 

The unfavorable, or debit, balances, are offset at the end of some 
convenient period, against the favorable or credit balances, in what is 
known as a Profit & Loss Account. For example, the net profit of $2,100 
achieved by John Smith in the illustration which has been given, it may 
be assumed, resulted from the transactions displayed in the following 
Profit & Loss Account: 


64 


JOHN SMITH. 
PRoFIT AND Loss AccouNT FOR YEAR ENDING DECEMBER 31, 1902. 
Dr, Ca 
UNG ESTE COD a $1,600 By Merchandise, Gross Profit...... $10,000 
BUVAROS ee PIES ee 2,400 
OES Os er 2,000 
MUEASR ACC i nes ak 6 
PURE i a ae he ek ee he wes 525 
0 Se 175 
EO <0 100 
nn wln es eas 500 
$7,900 
“ John Smith, Drawing Account, 
MRRP OE 3 Ue. ps oo Mined as ah 2,100 
$10,000 $10,000 


The foregoing Profit & Loss Account means that the assets increased, 
in the gross, $10,000, against which it was necessary to offset the unfavor- 
able balances, representing decreases of assets or increases of liabilities. 
The increase of net asset value from trading as shown is thus, $2,100. 

In this case not all of the net profit was left in the business, $1,800 
being withdrawn and charged to the proprietor’s Drawing Account as 
and when drawn. To this account should be credited the net profit, dis- 
closing the following condition: 


JOHN SMITH. 
DRAWING ACCOUNT FOR YEAR ENDING DECEMBER 31, 1902. 
Dr. Cr: 
MIVVAUIICAWAIS. 4. oo bee cee $1,800 By Profit & Loss, Net Profit....... $2,100 
“ John Smith, Capital Account..... 300 
$2,100 $2,100 





The amount of withdrawals was not consumed in making the turn- 
over, and is therefore not taken into the Profit & Loss Account. But 
the amount measures a reduction of assets, and must be offset against 
the nominal account measuring the net profit, the excess of the latter 
being the actual increase of net asset value in the business. 


65 


The usefulness of the information derived from keeping a record of 
all assets and liabilities, and a classified record of their increases and 
decreases, as disclosed in the foregoing accounts, especially when used in 
comparison with preceding statements, is too obvious for further com- 
ment. Single Entry compares two financial positions. Double Entry does 
likewise, but submits in the Profit & Loss Account the reason for any 
changes which may have occurred. 








THEORY AND PRACTICE OF ACCOUNTS — 
_ APPLIED ECONOMICS AND ORGANIZATION 


'. By HOMER ST. CLAIR PACE, C. P. A. (N. Y.)_ 





LECTURE VI 


PARTNERSHIP ACCOUNTS 


PROPRIETORSHIP! ye yee een Ea ie Nee aa HE See ole we 65 


PAR ENERGHIP ih. Pokal oe ee eG Ulan eae ae ee A Oo 
VUDIVISION. OF PROFITS » ou uci ook RUE ego ee Mesa eo 65 
rate ere ee 66 
PARTNERSHIP FORMED TO ORIGINATE A BUSINESS....... 66 


BET Se ets Tan oe ore Lee ae gt (Oi Tay 67 

: - Goop-witt By Nate. PRCA ReneS ee RRL a hear 1 ING 1 ee 68 
TREATMENT OF GOOD-WILL...... ayy se va te 69 

V PoRCHASE OF GooD-WILL BY FIRM. 2660. . 00800 004. 70 
‘TREATMENT IN BOOKS OF VENDOR..... BN AO Sea ar aero 

_ CHARGES TO GOOD-WILL... Hea hes Wits ed OLE ac 15 
Pe uencr ON Carita eee ae 75 


ADDITIONAL CONTRIBUTIONS OF CAPITAL............-- 76 


COPYRIGHT, 1915, BY 
HOMER ST. CLAIR PACE 


PACE & PACE — 


_ PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
: AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


30 CHURCH STREET. ‘ NEW YORK CITY 


MES Wt yt dis hey 
* 


=, rn 
we tana 
aaa 


hte / € 
444 





THEORY AND PRACTICE OF Accounts 
APPLIED ECONOMICS AND ORGANIZATION 


fe MER ST. CLAIR PACE, C, P. A. (N.. Y.) 
LECTURES VI 
PARTNERSHIP ACCOUNTS 


Proprietorship 
It is necessary to leave, for the moment, the development of the 
theory of Double Entry proper, in order to consider the complications 
that arise through the form of proprietorship known as partnership. 
Heretofore, a single proprietorship, by which is meant an undertaking 
owned by one person, known as a sole trader, has been assumed. 


Partnership 

Partnership is the relation created by the association of two or more 
legally competent persons, by express or implied agreement, for the pur- 
pose of contributing capital, skill or labor to a common undertaking, the 
profits and losses of which are to be shared. 

The agreement forming the partnership may be in writing, or it may 
be oral, or the association of the persons as partners may be implied from 
their acts, without either an express written or oral contract. 

It is usual, and the better plan, for partners to enter into a formal 
deed or contract of partnership, setting forth the amount of capital which 
each contributes to the undertaking, the proportion in which the profits 
and losses are to be shared, the allowance of interest, if any, upon the 
capital contributed by the partners, and the other matters affecting the 
partnership. | 

Division of Profits 

The partners may agree upon any division of profits and losses which 
to them may seem proper, but, in the absence of an agreement as to the 
division, they will be divided equally, irrespective of the capital con- 


tributed or the services rendered. 
Copyright, 1915, by Homer St. Clair Pace 


66 


While this is apparently inequitable, it may not be so in fact, for 
one partner without capital, through his ability to secure business, may 
contribute as much to the success of the business as a partner who con- 
tributes a large amount of capital. This principle arises frequently in 
practice in the settlement of partnership accounts. 


Accounts 

The accounts of a partnership are substantially the same as those 
of a single proprietorship, except that provision must be made for record- 
ing the capital contributed in the proper proportion between, or among, 
the partners, and for recording their respective withdrawals. 

A capital account is opened and maintained for each partner con- 
tributing capital, to which is credited the amount he contributes as cap- 
ital. This is determined from the partnership agreement, or from such 
other sources as may be available. Subsequent contributions are like- 
wise credited. 

Withdrawals, in some cases, are charged directly to the capital ac- 
counts, but the preferable method is to open a withdrawal account for 
each partner, to which withdrawals are charged as made. To this with- 
drawal account the partner’s proportion of the net profit is transferred 
when determined, and the balance of the account, the net increase or 
net decrease of capital, is taken to the partner’s capital account. 


Partnership Formed to Originate a Business 

In a partnership formed to originate a business, the books are opened 
by a Journal entry, setting up as asset accounts the items of cash or prop- 
erty contributed by the partners, and as liability accounts any offsetting 
liabilities, and crediting the net agreed value contributed by each partner 
to his Capital Account. This procedure establishes the equilibrium of the 
Journal entry. 

The simplest case would be the contribution of the capital in cash 
by the partners. Thus, A and B might form a partnership and each 
contribute $5,000 in cash, in which case the books would be opened by 
a Journal entry as follows: 

COBO caiaste a ones nie dct a aoe et Renn Sen a eRe $10,000 

To; A; Capital Accounts, wtesee ee $5,000 
)B, Capital Accotmnt eae eee es 5,000 


This would be followed by a suitable explanation, setting forth the essen- 
tials of the partnership contract, or at least referring to it. 

Although cash does not ordinarily pass through the Journal, opening 
entries, whether involving cash or not, should be recorded therein. From 


67 


the Journal the amount of cash may be carried to the Cash Book. If a 
Ledger Cash Account is maintained, the posting to it may be made from 
either the Journal or the Cash Book. 

Considering a more complicated case, if X, Y and Z form a partner- 
ship, and X contributes $1,000 in cash, Y contributes $500 in cash and 
merchandise of the agreed value of $500, and Z contributes real estate, 
of the agreed value of $2,500, with bond and mortgage thereon of $500, 
the opening Journal entry would be as follows: 


SUNDRIES To SUNDRIES 


For partnership of X, Y & Z 
formed to carry on the business 
of etc., etc., assets acquired and 
liabilities assumed, and _ the 
respective partners’ interests 
therein, being as follows: 


a DONTE ea ES SS Gane ge $1,500 

OAV AGYS DAU BA A Die 500 

GN eg OFS i head By Da oa es ee 2,500 
BOND & MORTGAGE........ $500 
Dear EA A CCOUN Geet ace soe hoes 1,000 
eA TE COOUT Getia eles shy von ere 1,000 
ee COOUI CA ons kote th yd 2,000 


$4,500 $4 500 


A different procedure, and one equally correct in principle, would 
be to make three entries, each dealing with the contribution of a partner. 
This would show exactly what each contributes, but this can be accom- 
plished, if it is considered desirable, in the explanatory part of the entry 
in the procedure given. 

A Balance Sheet, setting forth the agreed values, should be prepared 
and signed by the partners, and preferably incorporated in, or appended 
to, the partnership agreement, in order to make the interests of the re- 
Spective partners a matter of express written agreement. 


Conversion of Single Proprietorship to Partnership 
The partnership may be created by the admission of another to a 
business which has theretofore been conducted as a single proprietorship. 
Thus, if John Smith is a sole trader, and his capital as shown by 
his Balance Sheet is $10,000, and Charles Brown agrees to buy a one- 


68 


half interest on the basis of the figures shown in the Balance Sheet, the 
deal will be consummated by Brown paying to Smith, personally, the 
sum of $5,000. The cash passes directly to John Smith, and does not 
enter the accounts of the business. » 

If, as is most frequently the case, the same books of account are to 
be used for the partnership, John Smith, Capital Account, should be 
charged with $5,000, and an account under the caption of Charles Brown, 
Capital Account, should be opened and credited with a like amount. The 
entry carrying this into effect should be accompanied with an explanation | 
of the admission of the new member. A Balance Sheet should then be 
made and agreed to, setting forth the capital of the partners, as a basis 
for future accounting. 

The same result could be attained by payment of the cash into the 
business, charging Cash Account and crediting Charles Brown, Capital 
Account, and by a withdrawal of $5,000 in cash by John Smith, charging 
his Capital Account and crediting Cash Account. The former procedure 
is better, for it was not the intention that the capital should be, even 
momentarily, $15,000. 

The procedure would be different if the agreement provided that 
Brown should bring into the business the $5,000 as additional capital. 
In that case, instead of its being merely a sale of a part interest, or the 
dividing of the capital already in the business between two people, it 
would be an increase of capital, and the $5,000 would be brought into 
the business and charged to the Cash Account, and Charles Brown, Cap- 
ital Account, would be credited with the amount. 

A Balance Sheet prepared under such a condition, as a basis for 
future accounting, would show, so far as capital is concerned, that Smith 
contributed two-thirds, $10,000, and Brown one-third, $5,000. Never- 
theless, in pursuance of the rule given, the profits and losses would be 
divided equally unless there was an agreement to the contrary. 


Good-will 


It quite frequently happens that the vendor, that is, the one who 
sells, has built up a valuable business and reputation, and believes that 
the business, as a going concern, is worth more than the book values. 

This asset of well known name and reputation is known as Good- 
will, and from its frequent occurrence and importance in transfers and 
sales of this kind, merits special consideration. 

Good-will is the benefit derived from the well known name and favor- 
able reputation of a going concern. Lord Eldon’s definition of Good- 


69 


will is perhaps the best known—‘ Good-will is nothing more than the 
probability that the old customers will resort to the old place.”’ 

An amount of actual capital, invested in the conduct of a business 
with a well known name and trade standing, will bring greater results 
than the same amount of capital invested in the same place, in a similar 
business, but without the helpful influence of such a name and reputa- 
tion. 

Hence, it is apparent that Good-will may have an actual value, and 
it is this actual value that entitles it to be treated as an asset in account- 
ing. As a general principle, it may be raised legitimately on the books 
of a concern when its acquisition costs the reduction of an asset or the 
incurrence of an obligation. 


Treatment of Good-will 

In the case of the establishment of a partnership by the association 
of an individual with a sole trader, the former proprietor may be com- 
-pensated for his Good-will by an agreement, by which such an account 
is raised, the amount thereof being credited to the account of the former 
proprietor. 

Thus, if the net investment were $10,000, and the agreed value of 
the Good-will $5,000, and the old books showed the Capital Account of 
John Doe, proprietor, to be credited with $10,000, the new man to con- 
tribute $10,000 in cash, the entry would be: 


SUNDRIES To SUNDRIES 

For partnership this day formed 
by John Doe and Richard Roe, 
under the style of 

DOE & ROE 

to carry on business heretofore 
conducted by John Doe, value 
of Good-will and contribution 
of capital by Richard Roe, 
being, in accordance with part- 
nership agreement of this date, 


as follows: 
POLY VW TETSU aS erty aR $5,000 
JOHN DOE, Capital Acct.... $5,000 
For agreed value of Good-will. 
Re rim suai sol Seo oat ts. KR 10,000 
RICHARD ROE, Capital Acct. 10,000 


For cash contributed as capital. 


70 


The Balance Sheet would then disclose that there is $25,000 of Cap- 
ital in the business, of which $15,000 is credited to John Doe and $10,000 
to Richard Roe. 

Another method would be to pay to the former proprietor the agreed 
value of the Good-will in cash entirely apart from the books. This would 
insure to the former proprietor the full realization of the agreed value 
of the Good-will. If the amount were set up as an asset and credited to 
his Capital Account, as in the procedure first given, its eventual realiza- 
tion would, of necessity, be uncertain. If the cash were needed in the 
business, the former proprietor might contribute the cash so received, 
Cash being debited and his Capital Account credited. 

In no event would the incoming man receive credit for any part of 
the agreed value of the Good-will, but would be credited in his Capital 
Account for his contribution of capital, which, in the example given, was 
$10,000. The Balance Sheet, in case of the payment of cash to the former 
proprietor, would disclose that each had a capital of $10,000. If the busi- 
ness were later sold and the Good-will realized $5,000, the amount would 
be divided the same as other profits. 

Still another method, but one which apportions the benefit of the 
Good-will between the former proprietor and the incoming man, is for 
the latter to pay the agreed amount into the Cash Account of the new 
firm. A Good-will Account is credited with the amount, to be carried at 
a future time to the Profit & Loss Account and divided between the part- 
ners the same as any other profit. It is evident that this method divides 
the benefit in the proportion of the division of profits, instead of giving 
the whole benefit to the former proprietor, and achieves a different mathe- 
matical result from the procedures before given. 

It is apparent that the intangible personal property known as Good- 
will may be acquired and sold under substantially the same limitations 
as exist in the case of other assets. Its treatment in accounts will depend 
upon the agreement in the particular case, and the illustrations given, 
covering the most common agreements, sufficiently indicate the procedure. 


Purchase of Good-will by Firm 


In the case of the purchase of a business by a partnership, it is appar- 
ent that, if the net difference between the book value of assets and amount 
of liabilities exactly equals the purchase price, no Good-will Account need 
be raised on the books of the Vendee. But if the purchase price is greater - 
than such net difference, the assets must be increased in value, or a Good- 
will account, or other account, raised, in order that the cost may be shown 
and the Vendor may receive credit for the agreed purchase price. 


71 


Thus, in the case of a new firm taking over an undertaking upon 
the basis of a value greater than the net investment as shown by the 
books of the old firm, that is, when Good-will is bought in addition to 
the net asset value as shown by the books, it is often expedient, and en- 
tirely legitimate, to raise a Good-will account and charge it with such 
cost. | 

In such a case the assets to be taken over, including Good-will, are 
debited, and the Vendor credited, and the liabilities assumed are credited 
and the Vendor charged with their amount, leaving the net credit to the 
Vendor’s Account the amount paid for his interest in the business. 

The same result is accomplished, and, perhaps, preferably, by passing 
one entry, debiting the assets, crediting the liabilities, and crediting the 
Vendor to balance. In either case, the account with the Vendor is charged 
and closed as and when settlement is made with him. 

To illustrate, William Walker, in business as a sole trader, prepares 
at a certain date a Balance Sheet of his business, as under: 


WILLIAM WALKER 
Balance Sheet as at.......... 


Assets. Liabilities. 
NE WERT COretntOrSe ee ee. ees $ 1,475 
lip Sh a ar 1,750 Wm. Walker, Capital Acct. 12,925 
Meercnandise.....:.......- 11,200 
$14,400 $14,400 


Messrs. Jones & Baker form a partnership for the purpose of taking 
over the business of William Walker, and each contributes as capital 
$7,500 in cash. They agree with Walker to take over the assets of his 
business, except the cash, and assume the liabilities, paying for his net 
interest the sum of $14,000. Jones & Baker acquire by this the net inter- 
est, which is the difference between the value of the assets taken over, 
$12,950, and the liabilities assumed, $1,475, being $11,475. The difference 
between this net interest, $11,475, and the agreed purchase price, $14,000, 
being $2,525, is evidently the amount which they are required to pay 
for Good-will. 

Assuming that the book values are found to be correct and the Good- 
will, therefore, as stated, the Journal entries necessary to carry all of 


72 


the above transactions into the books of Jones & Baker, including the 
payment to the Vendor, are as follows: 


CAS Hiisnsevigoti Bal ols ose cl Ae ey $15,000 
TovAy JONES, GapitaliAccha Vis. aau $7,500 
+ ROBLA BAKER. CanitalwAcotiuaa. 7,500 
For partnership this day formed by 
A. J. Jones and Robt. Baker, under 
the style of 
JONES & BAKER 
to acquire and conduct the general 
merchandizing business heretofore 
conducted by William Walker, each 
contributing $7,500 in cash, profits 
and losses to be shared equally, in 
accordance with partnership agree- 
ment of this date, to which reference 
is hereby made. 


SUNDRIES To SUNDRIES 
For assets acquired, and liabilities 
assumed, as per agreement of this 
date with William Walker, viz.: 


MERCHANDISE 7229) rec cee eee ee 11,200 

DEBTORS (as per Schedule).......... 1,750 

HOODS WIDE Sree etek Aeterna eee eee 2525 
CREDITORS (as per Schedule).... 1,475 
WILLIAM WALKER, Vendor.... 14,000 

WILLIAM WALKER, Vendor............. 14,000 
TO: SADE ites oar tiny the eee 14,000 


For payment of balance due. 


73 


A Balance Sheet of the books of the firm of Jones & Baker, prepared 
after the above entries had been carried into effect, would be as follows: 


JONES & BAKER. 
Balance, mheetias auc... 





Assets. Liabilities. 
oot a $1,000 Creditors (as per Schedule) $1,475 
Debtors (as per Schedule). 1,750 A. J. Jones, Capital Acct.. 7,500 
Peerenandises:. 288.6 G we 11,200 Robt. Baker, Capital Acct. 7,500 
RET eh Cinco bse es ) 
$16,475 $16,475 


The agreed purchase price is sometimes less than the net investment 
as shown by the books. In this case the old book values of the assets 
should be scaled down, for there is no accounting justification for carry- 
ing in assets upon the opening of a business at figures greater than their 
cost to the undertaking. 

This erroneous over-valuation is usually effected by setting up the 
assets at the former book values and crediting a Good-will or other ac- 
count with the amount of such over-valuation, this credit later to be 
carried to Profit & Loss. It is not a profit, however, but simply meas- 
ures an overstatement of the cost of assets. 

We have now considered the acquirement of a business by a firm 
from three possible viewpoints: 

1. Acquirement at a price that exactly equals the investment as 
shown by the books, which requires no Good-will Account; 

2. Acquirement at a price greater than the investment as shown by 
the books, involving, if values are correctly stated, the setting up of a 
Good-will Account; and 

3. Acquirement at a price less than the investment as shown by 
the books, which, in the books of the new firm, requires no treatment 
of Good-will. 


Treatment in Books of Vendor 
The amount received for Good-will may, upon the books of the ven- 
dor, be credited to Good-will account. If this account is already charged 
with an amount greater than the amount received, the net result will 
be a debit to Good-will Account, representing a loss through its sale, to 
be treated as are the other losses in closing the books. 
If there is no Good-will Account, or if the amount credited exceeds 
the amount already standing to the debit of Good-will, a net credit will 


74 


result, measuring the profit made, to be treated as are the other profits 
in closing the books. 

In case the business is sold at a price less than the book values, Good- 
will does not enter into the matter. In such a case the amount received 
for each particular asset may be credited to the asset account, and if 
a debit balance remains, it should be treated as a loss. Profits and losses 
on the realization of assets are divisible the same as trading profits and 
losses. 

Another method is to raise a Realization & Liquidation Account, 
charging it with the book values of the assets and crediting it with the 
liabilities, the asset and liability accounts being respectively credited and 
debited to close them out. 

The Vendee is charged with the selling price and the Realization & 
Liquidation Account is credited, and the resulting balance, being profit 
or loss, is carried to capital the same as other nominal elements. This 
may include compensation for Good-will and thus obviate the necessity 
for raising a Good-will Account. 

Upon payment by the vendee, the books may be finally closed and 
balanced by the withdrawal of the cash and an entry charging Capital 
and crediting Cash. 

If this procedure were followed in the case of William Walker, Journal 
entries would be passed closing the assets, other than cash, and the lia- 
bilities, into a Realization & Liquidation Account, which would then be 
closed into Capital: Account, as appears from the following: 


REALIZATION & LIQUIDATION ACCOUNT. 








Dr, Gr, 
LO IPULOTS as tc so eae cee $ 1,750 By Creditors. 5s +... s asi cee $ 1,475 
mi Merchandise! 59-3 ¢2 Yh eee een 11,200 “Jones & Baker, Vendee........ . 14,000 
“Wm. Walker, Capital Acct., 
TONG OO UR ee sek os seen eS Peay AS 
$15,475 $15,475 














Wn. WALKER, CAPITAL ACCOUNT 
Dr. Cr. 


To Cash, withdrawal to close books. $15,450 Pvslnvestment. ti. djs. . 35 dae $12,925 
DHT. Oe thse MARCL: sxc co @ate 3:5 omy k 


$15,450 $15,450 

















75 


The foregoing procedure may be used whether or not the question 
of Good-will enters into the matter. It is especially useful in case the 
realization and liquidation extends over a period of time and consists of 
many transactions. 


Charges of Gandini 


Advertising and other expenses incurred in a business, even though 
they may help establish a well known name and reputation, should not 
be charged to Good-will, but should be charged off in the Profit & Loss 
Account the same as other expenses. Such expenditures may, or may 
not, result in the creation of Good-will. If the Good-will is sold, and 
a profit realized thereon, it will then be time enough to carry it into the 
accounts. 

Extraordinary expenses, as for example, an initial advertising expense 
which is greatly in excess of the normal amount to be expended, may be 
distributed over a longer time than one accounting period, charging it 
against Profit & Loss over two or three years instead of one. Even in 
such cases, however, the quicker it is charged off the more conservative 
the practice. 

Good-will, standing as an asset upon the books of a concern, is always 
a subject for close scrutiny and should represent only the actual cost of 
its acquisition. It should not be loaded with expenses incurred in building 
‘ up the business, and should not be manipulated to produce a favorable 
result in the Profit & Loss Account. 


Interest on Capital 


Interest is frequently allowed, under the partnership agreement, 
upon the capital contributed by the partners, and is a charge against 
the Profit & Loss Account before the net results are carried to the part- 
ners’ accounts. 

If the concern has sustained a net loss, instead of making a net profit, 
the interest charges are nevertheless made to the Profit & Loss Account, 
and the partners’ accounts credited with the respective amounts of interest. 
This, of course, increases the amount to be carried to the partners’ ac- 
counts as a charge, but the result will, perhaps, be divided equally, or at 
least upon a basis different from that of capital contributed, which neces- 
sitates carrying out the procedure indicated. It is really a matter of 
adjustment between the partners, usually to reduce to an equitable basis 
unequal contributions of capital. 

No interest is allowable upon capital contributions unless an express 
agreement is made to that effect. 


76 


While the interest upon partners’ accounts will appear in the Ledger 
Profit & Loss Account, in preparing a Profit & Loss Account to disclose 
the net profit of the business, care must be taken not to carry in such 
charges as an expense. The net profit is determined regardless of such 
adjustment between partners, and brought down as a balance in a sub- 
sequent division, and against it are charged the amounts to be credited 
to the respective partners as interest on capital. Such allowances are 
made to adjust unequal contributions and, in view of the fact that a con- 
cern is supposed to have capital with which to transact business, cannot 
be regarded as an expense. 


Additional Contributions of Capital 

If partners bring in cash or property from time to time, the proper 
capital account will be credited with the agreed value. 

If the item brought in is property, and its value is agreed upon, any 
loss upon its subsequent realization must be borne by the firm in the 
same proportions as any other loss. 

If the value of property contributed has not been agreed upon by 
the partners, the Capital Account of the contributing partner will be 
credited with the amount of actual proceeds, not with the value he may 
have placed upon it, without the consent of his partner, at the time of 
bringing it into the business. 

Only the contributions made as capital are considered as capital— 
other contributions would bein the nature of advances or loans to the 
firm. 


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THEORY At AND PRACTICE OF ‘ACCOUNTS. 
| _ APPLIED ECONOMICS AND ORGANIZATION. 


ie a CLAIR PACE, C. P. A. (N. Y.) 
LECTURE VII. 


_ THE RECORDING OF PURCHASES AND SALES. 


PHB ouENAL ils. ele Sy eas aha yest MD RIL EH! 
ptnvorrs, Rives And STATEMENTS 30's. 0h Vea lS 77 
- AMputrication OF THE Journat PROPER @ {0 10/ eh eM tae MCL ene 78 
 Purcuase Boor... aah Voce nse ashe ek i PRN ta Rea a OG Mu ke Pt) 

PRwtoanen Poucuasts fo hus ee Ma se seman 83 
me CREDITORS’ LEDGER Accs. ena ele UME a SHS Ge Fe Se aan 83 
FE SALES Book. CO aa ie oa tp cea Mite a Ncatiebo ain git! eas fn 84 
_» RETURNED SatMee. oo Gk at ane rR Sea E INE CNC Nas ae 85 
i CUSTOMERS’ MEBOGER Gree ust) Cpa tae earn Meee i sisineN nates 85 
 GrneRAL LEDGER.......0...05.5. SGI Cig SM Gal RRO BCA 86° 
- Voucuer RECORDS | corn 4 DAC ea ay, PUA se be 86 
Bis RECEIVABLE AND BILLs PAYABLE RECORDS: Bais ana) EOE 
es ee. ‘OF THE JOURNAL. ..... Repu ielts poy ee HA ga eg Mee. 
ae ne es ue es ca ei oe EN, ‘CopyriGut, 1914, By 


- Homer St. Crair’ Pace 


ite 


mete 


Mi 





THEORY AND PRACTICE OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


PmenOMER ST, CEAIR PACH. C. P. A. (Nw Ye) 


LECTURE VII. 


THE RECORDING OF PURCHASES AND SALES. 


The Journal. 


The Journal, in Double Entry bookkeeping, is a book of original 
entry, designed, in the first place, to contain all of the original chrono- 
logical record of financial transactions. The first step in dividing the 
Journal into different books, for greater economy of effort, consisted of 
the invention and use of the Cash Book, as has been set forth in a pre- 
vious Lecture. 

After the elimination from the Journal of the cash transactions by 
the use of the Cash Book, a scrutiny of the remaining entries will disclose 
the fact that they consist, largely, in the ordinary trading concern, of 
purchases and sales on credit. 

It will be apparent that the credit purchases are principally of mer- 
chandise, although the various expenses may, to some extent, find their 
way into the accounts, through Journal entries, before liquidation. The 
credit sales, on the other hand, will be almost entirely on account of 
merchandise. Expenses which are not entered except in the Cash Book 
as paid, and purchases and sales of merchandise for cash, will be recorded 
in the Cash Book, and need not appear in the additional records which 
it is necessary to devise in order to relieve the Journal. 


Invoices, Bills and Statements. 


An invoice, as the term is ordinarily understood, is a detailed list 


of items of merchandise, with prices, supplied to a purchaser or consignee, 
Copyright, 1914, by Homer St. Clair Pace. 


78 


for their use in checking the receipt of the goods. In addition, if the 
invoice covers a purchase, the items may be compared with the order, 
and other records, if necessary, in order to determine that the quantity 
and prices are correct. Upon the establishment of the regularity of the 
invoice, it should be approved by some one in authority, and then entered 
in the financial books. Under the definition, an invoice may apply to 
outgoing, as well as incoming, merchandise. 

A bill may be defined as a statement of an account, or a claim for 
an amount due, whether for merchandise, services, or any other con- 
sideration. 

In common practice, the term bill is used interchangeably with in- 
voice, although the latter term is more often used in its application to 
incoming merchandise. It will be seen that an invoice, strictly, is but a 
list of items of merchandise, with prices, and is not necessarily a claim 
for an amount due. This is apparent in its use with consignments, where 
goods are not actually sold. The term bill is more comprehensive, and 
may include items other than merchandise. It is properly used when it 
covers a statement or claim for an amount due. 

The term Statement of Account or Statement is most frequently 
applied to the monthly recapitulation of invoice or bill totals which is 
rendered by a vendor to a vendee. Thus, if during a month, ten different 
shipments of merchandise were made, a statement would be rendered at 
the end of the month, showing the amount of each invoice or bill. 


Amplification of the Journal Proper. 


In pursuance of the principle ‘‘the whole equals the sum of the 
parts,’ common to modern books of original entry, it will be necessary 
to collect items of a similar nature in columns, to be posted, as to the 
personal accounts affected, in detail, and as to the class of transactions 
in periodical totals. | 

The original application of the principle to the purchases and sales 
transactions consisted of adding two money columns to the Journal, 
one to carry the merchandise purchases, and one to carry the merchan- 
dise sales, until the end of the month, the totals to be posted respectively 
to the debit and credit of the Merchandise Account. 

The personal accounts affected are named in each entry, and, in 
case of a purchase, the creditor’s account is credited from the entry; in 
case of a sale, the debtor’s account is charged. The postings to the per- 
sonal accounts, in conjunction with the total postings, effect the Ledger 
equilibrium. 


79 


The Journal may be ruled in various ways to accomplish this result. 
The ruling and entries which follow illustrate the procedure: 


Dr. 


Purchases! General] L.F. 


NEW YORK, JANUARY, 1902 


Names of Accounts and Detail 


Cr. 


L.F.|General| Sales 


— | Sf | | 2 ee 


$6,000 
$5,000 

1,500 
75 
1,250 
625 

2,800 
4,700 
200 
29 

$10,300 


200 


10 


208 


200 


205 


110 


120 


2 
MERCHANDISE, 200 A @ $30, 1% 30 
To J. F. JONES 


2 
BAGGOTT & CO., 100 A @ $50, 2% 10 
To MERCHANDISE 


3 
MERCHANDISE, 100 B @§ se 1% 30 
To DENNIS & 


be 
FURNITURE & FIXTURES, 1 desk 
To DIETZ CO. 


+) 
THE BAYONNE CO., 50 B @ $25, 2% 10 
To MERCHANDISE 


BAGGOTT & ae 25 B @ $25, 1% 30 
MERCHANDISE 


16 
Na ee aa rr 100 A @: ae 1% 30 
To J. F. JON 


31 
BARMON & one 100 A @ $47, 1% 30 
To MERCHANDISE 
31 
To SMITH REALTY CO. 
31 
CARTAGE, J ane 
To BAKER EXPRESS CO. 
31 


MERCHANDISE, total for month 
To MERCHANDISE 


RENT, Jan. 





155} $6,000 
x $5,000 
160} 1,500 
173 75 
x 1,250 
x 625 
155) 2,800 
xX 4,700 
174; 200 
175 25 
100 $11,575 


Under this method, the personal accounts are posted as the record 
is made from day to day, and their state may be determined at any time, 
The Merchandise Account is posted monthly. 

Additional columns could be added to cover other classifications, to 
be posted monthly. For example, an Expense column could be added to 


80 


hold items of expense. The development of the Journal in this way, 
however, is limited by the fact that, in a large business, the transactions 
are sO numerous that a division of the Journal into different books is 
necessary in order to enable more than one bookkeeper to work upon 
the records. 

The study of the Journal method is useful, not so much on account 
of its practical utility, although it is still used in various forms, but rather 
as a means of leading logically to the consideration of the two important 
books in modern accounting, based upon the principle stated, that are 
the outgrowth of the method which has been briefly described. 


Purchases Book. 


If the column in the Journal in which purchases are recorded, and 
the details belonging thereto, are taken bodily out of the Journal and 
bound in a distinct volume, there will be produced a book known in ac- 
counting nomenclature as the Purchases Book, or the Invoice Book. 

From its Journal origin it will have for each transaction, the date, 
the name of the concern from which the purchase is made and which 
is entitled to receive credit therefor, the details of the purchase, and the 
amount. These are the facts recorded in a simple form of Purchases 
Book. 

The date column occupies the extreme left, and, progressing to the 
right, there may be provided a Ledger folio column, a column for cred- 
itor’s name, column for details of purchase, column for invoice number, 
and column for amount of invoice. 

Postings are made from day to day to the credit of the various cred- 
itors named, and the proper Ledger folio is placed against the name of 
each creditor in the column provided for that purpose. 

At the end of the month, to complete the double entry, the total of 
the amount column is charged to Merchandise Account, or to Purchases 
Account, if purchases and sales are kept in distinct accounts, and against 
the amount thus carried from the Purchases Book is placed the Ledger 
folio. 

Or, a summary entry may be passed in the Journal, debiting the 
Merchandise or the Purchases Account and crediting Sundry Creditors, 
noting that the latter have been posted in detail from the Purchase Book. 

As in the method of adding columns to the Journal, the use of the 
Purchases Book enables one to ascertain the balance of the creditor’s 


81 


account from the Ledger at any time, while the Merchandise or Pur- 
chases Account will show the proper balance only when the postings are 
completed at the end of the month. 

By the use of the method outlined, the work is reduced nearly to the 
simplicity of Single Entry, but with the balancing and analytical benefits 
of Double Entry. 

If Merchandise alone is passed through the Purchases Book, and there 
is only one class of Merchandise, or it is not advisable to separate the 
classes, a single column is sufficient for the amount of the invoices. It is 
sometimes desirable, however, where items other than merchandise, such 
as expense items, furniture or fixtures, etc., are purchased on credit, to 
provide additional columns in the Purchases Book therefor, and, in some 
cases, it is desirable to classify the merchandise purchased, providing a 
column for each class. 

Thus, it might be desirable to provide a total column, supplemented 
by three distribution columns, one for Merchandise, one for Cartage and 
one for Sundries, the creditor receiving the posting from the total column. 
At the end of the month Merchandise or Purchases would be charged 
with the total of the Merchandise column, and Cartage with the total of 
the Cartage column. 

The Sundries column, designed to take care of items not falling 
within the scope of the other two columns, will contain items chargeable 
to various accounts and, therefore, cannot be posted in total at the end 
of the month. On the contrary, space is provided next to this column 
in which to designate the account to be charged, and for Ledger folio, 
and the charge is made to the particular account. 

Thus, by debiting Merchandise or Purchases for the amount of Mer- 
chandise, Cartage for the total as shown in its column, and debiting the 
particular accounts for amounts shown in Sundries column, debits will 
be made aggregating the total credited to the various accounts with the 
creditors. 

In case the merchandise purchases were classified, and a column 
given to each class, the total of each column would be posted, ordinarily, 
to the debit of a Ledger account, opened under a suitable caption, to 
show the purchases of the particular class of merchandise. 

The Purchases Book should be ruled to meet the needs of the busi- 
ness for which it is designed, and the following ruling, in which the trans- 
actions given in the Journal procedure are used, is given merely for illus- 
tration: 


82 


PURCHASES, JANUARY, 1902. 


Account to Inv 
































Date |L.F. be Credited Details No. | Total | Mdse. Cartage} Sundries |L.F.} Amount 
Cr. 
2 T5525. Pee JONES eae cs 200 A @ $30, 1% 30] 210 | $6,000} $6,000 
3 160} Dennis & Co..... 100 B @ $15, 1% 30} 211 1 500 1 500 
3 173) (Diets Cou ies Tdesle oa ct. ae oe ao ee 75 Fur. & Fix.| 10 $75 
16 LSS ey aby jones... es 100 A @ $28, 1% 30} 213 2,800 2,800 
31 174| Smith Realty Co.| Jan. rent........... 214 200 Rent, dias} BAO 200 
31 ake Baker Express Co.| Jan. cartage........ yA es Zo 25 
‘ge 
x x A Otal Purchases} ssn eee ve ea. Cees Y $10,600 
31 100 Merchandise 0165 shat kbk oe $10,300 
31 120 Cartasets 34 vey iene oe ids tee $25 
31 | x Sivsidtiea yaaa) eine Vanes ee $275 





The use of a Total column provides a check upon the accuracy of 
the distribution of the items, and is especially useful where there are 
many columns. 

In order to preserve the Double Entry principle, the total of the 
various columns charged at the end of the month must exactly equal 
the sum of the credits posted in detail from day to day. The principle is 
the same, whether one column or twenty be used in the Book, and once 
thoroughly grasped, mere multiplicity of columns should not confuse. 

A great economy of effort is sometimes effected in a Purchase Book 
by the use of an inside, or indent, column. For example, city printers 
are apt to carry but little stock, ordering the stock for each job as it is 
required. This involves, in a business of any magnitude, a great number 
of credits, each ordinarily small in amount. The labor of entering such 
invoices in the Purchases Book from day to day, and making the postings, 
is heavy and out of proportion to the amounts involved. 

To relieve this condition, it is frequently advisable to provide an 
inside, or indent, column, in the Purchases Book. The invoices are held 
until the end of the month, and are then sorted, so that the invoices from 
each creditor are arranged in order of dates. The name of each creditor 
is entered once, and against it, in the indent column, the amount of each 
invoice is entered. ‘The total of such invoices, being the total amount of 
purchases from the particular creditor for the month, is then carried into 
the regular column, and one posting to the creditor’s Ledger account is 
made to cover. 

Inasmuch as discounts are figured, in that particular line of busi- 
ness, from the end of the month on the total purchases for the month, 


83 


the Ledger account, as posted in the foregoing method, supplies all the 
information that is ordinarily required. The disadvantage, if any, in 
the procedure, is that it collects the work to be performed at the end 
of the month, but this is more than offset by the great saving in entering 
and posting the items. i 

A method formerly in common use consisted of pasting into an Invoice 
Book the approved invoices. Either from the invoice itself, or a column 
provided on the extreme right of the sheet to which the invoices are pasted, 
the credit amount is posted to the creditor’s account, or to a general Ac- 
counts Payable Account, Merchandise being charged with the total. This 
method is clumsy and generally unsatisfactory in use. 


Returned Purchases. 


Merchandise is frequently returned, for one reason or another, to the 
vendor, and if accepted, a credit memorandum is received covering the 
transaction. Such returns are known as Returned Purchases, and ob- 
viously require treatment in the accounts the inverse of that accorded when 
the purchase was made. ‘Thus, if Merchandise were charged, and Belding 
& Co. credited, when the merchandise was bought, upon a return of all or 
a part thereof it would be necessary to charge Belding & Co. with the 
purchase price of the returned goods, and credit Merchandise. 

The same ruling as that used in the Purchases Book may be used in 
recording Returned Purchases, so that, if the returns are not numerous, 
a page in the Purchases Book may be set aside for the returns of the month. 
The name of the creditor is inserted in the usual column and the amount 
is carried out and proper distribution made. The creditors are charged, 
and at the end of the month the Merchandise or other accounts are cred- 
ited, being the inverse of the regular Purchases Book procedure. 

If the returns are numerous enough, a separate Returned Purchases 
Book may be provided and ruled as indicated. 


Creditors’ Ledger. 


It is usual, in the larger undertakings, to provide a separate Ledger 
for the accounts of creditors, known as a Creditors’ Ledger or Purchase 
Ledger. It may consist of a single Ledger, or may be divided into several 
ledgers, to suit the needs of the particular business. 

The approved method is to make the detailed postings from the 
Purchases Book and Cash Book to the accounts in the Creditor’s Ledger, 
and, in the General Ledger, to operate a summary, or controlling, account 


84 


to show in summary form that which is posted in detail to the subsidiary 
Ledger. The subject of controlling accounts will be considered fully in 
a subsequent Lecture. 


Sales Book. 


In the amplified Journal procedure shown, a chronological record of 
sales was made, the items being posted from day to day to the debit of 
the customer, and a total posting made to Merchandise or Sales account 
at the end of the month to establish the equilibrium of the Ledger. No 
new principles are involved in passing from this procedure to a separate 
record, known as the Sales Book, in which the sales are recorded as made. 

While the Purchases Book is liable to carry items other than Mer- 
chandise, the Sales Book, owing to the fact that little is sold but mer- 
chandise, ordinarily carries nothing else. 

It is frequently desirable to divide, by the use of columns, the total 
sales between classes of goods, in order to show the sales of each class 
or of each department of the business. In such a case a total column 
would be used and the distribution made in columns under the desired 
captions, and at the end of the month the totals of the distribution col- 
umns would be credited to the various Ledger Sales accounts raised to 
conform. 

Where it is desirable to keep a record of the sales made by salesmen, 
for the purpose of computing commissions, or other purpose, distribution 
columns may be provided in the Sales Book for that purpose. Thus, the 
total column would show the total sales for the month, and a column 
would be provided for each salesman and a general column for sales made 
by the office, the amount achieved by the summation of the distribution 
column totals exactly equalling the total sales column amount. 

The following illustrates the form and use of a simple Sales Book: 


SALES, JANUARY, 1902. 


Date | L. F. Accounts to be Debited Details Amount 
Dr. 
2 200 iol Baggott i fone a alee ook phd 100. Ay 210s ic eshte cea $5,000 
5 206.1 ane Bayonne Cor a7 pee 50D, Sop a anes aoe 1,250 
12 200,.«ii Bargott.& Goi tic eo. eel 25 | Bs 187130 sacs 4s os... 5 625 
31 a Bannon of Cosas 1s cea oe eee TOURS 1s OU. aa va sch a eee 4,700 
T 


100 Merchandise... .< ..4.) us<,- total sales for month.. ........ $11,575 


85 


In lieu of the use of the regular Sales Book, a common method is 
to bind in the form of a book, blank bills in duplicate, and by the use 
of a carbon sheet a duplicate is made of each bill. The original, which 
is perforated for the purpose, is taken out and rendered to the customer, 
and the duplicate, being a permanent sheet in the book, serves as the 
original entry from which the posting is made. It is customary to have 
three such books in operation, one for extra long bills, being one to a 
page, one for medium length bills, being two to a page, and the third 
for short bills, three to a page. The totals are carried forward from page 
to page, and at the end of the month the sales are totaled and posted to 
the credit of Sales Account. 

The labor-saving effected comes from the fact that in making out 
the bill to be rendered, which would have to be prepared in any event, 
a duplicate is made which answers as the original entry. The disadvan- 
tages are that the books consume a large amount of space, and it is diffi- 
cult to obtain an idea of how the sales are running from day to day from 
an inspection of the book, owing to the fact that at most but three sales 
appear on a page. And again, if it is desirable to divide sales between 
classes of goods the columnar arrangement cannot be worked out so well 
by the duplicate-bill method. 

There are many forms of sales records in use, but from the procedures 
given a knowledge of principles and practice, sufficient for the purposes 
of this Lecture, may be obtained. 


Returned Sales. 

In the same manner as purchases may be returned to creditors, cus- 
tomers of the concern may return merchandise bought, and, under certain 
restrictions, receive a credit memorandum for the selling price thereof. 
Such returned sales constitute a condition the inverse of sales, and may 
be passed through the Sales Book on a page set apart for that purpose. 
Or, in case the business justifies it, a separate Returned Sales Book may 
be used. 

In either case, the procedure is the inverse of Sales. The customers 
are credited, and Sales or Merchandise Account charged. 


Customers’ Ledger. 

If the business justifies it, it is usual to provide a Ledger for cus- 
tomers’ accounts, known as a Customers’ Ledger or Sales Ledger. It 
may be a single book, or divided into several books, to meet the needs 
of the particular undertaking. The Customers’ Ledger may be controlled 
by a summary account in the General Ledger, in the same manner as 
the Creditors’ Ledger. 


86 


General Ledger. 


The Ledger, in which the accounts other than those with creditors 
and customers are contained, is known as the General Ledger. 

The Creditors’ Ledger and Customers’ Ledger which have been de- 
scribed are but sections of the Ledger classification. ‘Therefore, in the 
absence of accounts in the General Ledger which control the subsidiary 
ledgers, it is necessary to include the accounts receivable, as disclosed 
by the Customers’ Ledger, and the accounts payable, as disclosed by 
the Creditors’ Ledger, with the accounts of the General Ledger, in order 
to achieve a Trial Balance. 


Voucher Record. 


In the Purchases-Book method of recording purchases, a Ledger 
account is opened with each creditor, to which the various debits and 
credits are posted. Ordinarily, the account with the creditor, disclosing 
balance due, the total purchases, and other information, serves a useful 
purpose with a minimum of labor. 

In large corporations, particularly railroad corporations, purchases 
are made from so many concerns that the opening of Ledger accounts 
becomes burdensome. This is particularly true in view of the fact that, 
under the method of asking for bids and purchasing from the lowest 
bidder, the same article may be bought at different times from various 
traders. Under such conditions many accounts are opened and closed 
with but a single transaction. 

The obvious way to overcome the necessity for individual accounts 
is to provide a summary account in the General Ledger, to which the total 
due creditors on account of purchases may be posted as a credit, and 
to which the total payments may be debited, the resulting net credit 
disclosing the amount due creditors. This will overcome the necessity for 
opening a Ledger account for each creditor, but provision must be made 
for determining the amount due the individual creditor at any time. 

The attempt is often made to accomplish this result, in small con- 
cerns, by posting from invoices, usually pasted in an Invoice Book in 
order of dates, to an Accounts Payable Account. Payments made to 
ereditors and discounts taken are charged thereto, and the credit bal- 
ance should show the total due creditors. This method, correct in prin- 
ciple, is often unsatisfactory in operation because dependence is placed 
upon memoranda to determine the amount due the undividual. The 
opening of individual Ledger accounts is, as a general rule, justified in 
a business small enough to render the use of this method successful. 


establishes the accuracy of accounts or other facts. 


87 


In large undertakings the successful maintenance of a general, or 
summary, account with creditors, is insured by the use of the Voucher 
Record, or Voucher Register, as the book of original entry, and the aux- 
iliary document known as the Voucher. 
The term voucher, is used, broadly, to designate a document that 


sense a voucher is a receipt, acknowledging the payment of money. 
In its use with a Voucher Record, a voucher is a form of receipt, 
with provision for certain additional memoranda, not essential to the 
receipt proper, in accordance with the needs of the particular concern. 
A simple blank form of voucher is as follows: 





(Distribution showing accounts to be charged. 
This could be shown on back of Voucher.) 


IOWA MILLING CO. 
To (creditor) ‘( hd AGI RS A ARR EGE he ee nn ok Dr. 


(Details of items covered by voucher.) 


Approved: Approved for Payment: 
EE IS We LB eAS, can, hr eek a) OPA EY SOLES. ASTER oO. canine Meme 
Approved: 
EOS osha oh vida woh rors 
EE URTPESIE MEDI E ST yp he 5 OE ES te ee ks weld cena ehie bis 190. 
RECEIVED of IOWA MILLING CO., the sum of 
Tart Mea Crater ested Ce oe gd Feo cS eas Maw Be ROR. sis 88 erm d A —Dollars 


in full settlement of above account 


67 66 eke a Ge ch OS 05:6 0 C0 eV ee oO KO GF HE Oe oe ee 


In a more restricted 


88 


The voucher which is being described should not be confused with 
the voucher check. The latter is a form of check upon which appears, in 
more or less detail, a statement of the items payment of which is made 
by the check. The use of the check constitutes a receipt for the items 
specified. The statement of items appears on the end or back of the check, 
and is limited as to detail unless a check is used too large for convenient 
handling by the banks. While it often serves a useful purpose in general 
accounting, it is particularly useful in such cases as the payment of a 
dividend, the number and amount of the dividend being printed or stamped 
on the face of the check, and the endorsed and paid check furnishing a 
sufficient receipt. The form for use with the Voucher Record is not ordi- 
narily combined with a check. 

Upon receipt of an invoice the voucher is prepared and the necessary 
details filled in. The approval as to price and receipt of goods is indicated 
by the signature of the proper official. It is then approved by the auditor 
for entry in the accounts, and finally by the General Manager, or other 
official having the authority, for payment. A check is drawn for the 
proper amount and forwarded to the creditor with the voucher. The 
latter should be receipted and returned to the payer. It is then filed 
in the order of its number, together with the papers directly applicable 
thereto. 

The voucher is entered in the Voucher Record, a book designed, 
in conjunction with the voucher, to take the place of the Purchase Book 
and the individual creditors’ accounts. In a simple form, it will provide, 
on one page for the number of the voucher, date, name of creditor, terms 
and other details, amount, date and manner of settlement and Cash Book 
or Journal folio. On the opposite side, or page, provision is made for 
distribution columns, under the captions of the various accounts to which 
the purchases should be charged. Into these columns the amounts of 
the vouchers are distributed. 

It is apparent that the rulings may vary to meet the needs of dif- 
ferent concerns, but the most complicated examples will differ from the 
foregoing in little except columnar development, and will embrace no 
new principles. 


89 


The ruling and uses of the various columns will be more fully appar- 
ent from the following: 


VOUCHER RECORD, JANUARY, 1902. (Right page.) 


f Voucher : Payment. 
Date Creditor Number} Terms & Details | Amount |——-—————————— 
Date | Manner 


i a | aS | | 




















ee eoement 2 CO.,. ..... ..- LOOTiO d netas0e se eee: $850 1-4-’02 C 
Soueele: 6. DTO... =... 2... 10023 fenet-SO ee nee ees 1,000 | 1-10-02 & 
4 | Dick & Bye.... . erate ol 10038.) LTO sys ae 125 
Ton pomement.: Co 21.02.0658. 1004) }; net SO pions esa 750 
meee tray Os CO. es. tse. 1005: +i ety? pier ee were 400 | 1-31-’02 & 
Be eOnes...a....0.....} L006. P.nety Agia eee. 2,000 | 1-31-’02 BP 
$5,125 
VOUCHER RECORD, JANUARY, 1902. (Left, or distribution, page.) 
Build- Ex- Miscellaneous Charges 
Mchy. | Tools ings |Supplies| Repairs | penses 
Accounts L. F. | Amount 
$700 $150 
$1,000 
$75 $50 
550 200 
$400 
Real Hstates s,s sars : 100 | $2,000 
$1,250 $350 | $1,000 $400 $75 $50 $2,000 





ooaoaeaooSS=s_(w_WOOEQQOQEQQQqqqq|— OS —————————S_SE_s s6sO8«SSS=_ 





It should be understood that the foregoing rulings would be placed 
in opposition, and the distribution made, in accordance with the voucher 
details, as the voucher is entered. The distribution columns are often 
placed to the right, instead of to the left, as shown above. This is a 
matter that is governed entirely by convenience. 


90 


A Journal entry would be made at the end of the month, to bring 
the transactions into the Ledger, as follows: 


SUNDRIES To UNPAID VOUCHERS. ae $5,125 
For January purchases, viz. : 
MACHINERY .. ..c:- see se $1,250 
LOO S Ty caccnse + a pe eR ede 350 
BUILDINGS: Ae tee aetna: 1,000 
SUPPLIES...) Gi Ge Berea ie 400 
REPAIRS... sk cetoetee een woth 75 
EX PEN SED Wie. ace eee tie eas ee 50 
REAL ESTATE (posted)..........: 2,000 


The Real Estate, entered in the column for miscellaneous items, 
was posted from the Voucher Record, although it is a common custom 
to recapitulate such items at the month-end and enter in Journal, to be 
posted therefrom. Thus in the case of several entries affecting Real 
Estate, the amounts would be added and posted in one total amount. 

In the Cash Book, payments to creditors on account of approved 
vouchers are collected in a column under a suitable caption, and at the 
end of the month a Journal entry is passed charging Unpaid Vouchers 
Account and crediting Cash Account. As each payment is made the 
voucher is checked in the Voucher Record, either by a check mark or 
by entering date of payment. If settlement is made other than by Cash, 
as by giving a bill payable, the entry is passed through the Journal, and 
the Unpaid Vouchers Account will receive the proper charge. 

The unchecked vouchers in the Register should equal, in amount, 
the liability as shown in the Unpaid Vouchers Account. In the illustra- 
tion given the Unpaid Voucher Account would be as follows: 


UNPAID VOUCHERS. 


Dr. Cr. 
190 1902 
Jan. 31 RR cist, 2b 1.1 $2,250 |}. Jan.i31)) By Sundries.(7.. 2aaen 26 | $5,125 


To Cas 
Jan. 31} ‘“ Bills Pay. (Journal)| 26 2,000 
OA 4 oh IDGLONEE, Wick ect tee 875 





$5,125 $5,125 
Feb. 1/| By Balance. ........ $875 











91 


The balance due, $875, will be found to consist of the unchecked 
items on the Voucher Record, viz., No. 1003 for $125 and No. 1004 for 
$750. The approved and entered, but unpaid, vouchers, should be checked 
against the unchecked vouchers in the Voucher Record and the total 
liability as disclosed by Unpaid Vouchers Account. 4 

The Voucher Record is capable of indefinite expansion in the matter 
of distribution columns. It has been deemed best to illustrate the method 
with simple rulings and few transactions, in order not to obscure the prin- 
ciples involved. 

The advantage of the method lies in the elimination of ledger accounts 
with creditors and the heavy labor incident thereto. Its chief disad- 
vantage lies in the lack of a record of all the transactions with a particular 
creditor in form convenient for reference. This, in many lines of business, 
is a serious defect. It may be overcome, to some extent, by means of an 
index operated in conjunction with the Voucher Register, showing the 
total transactions with each creditor. — 


Bills Receivable and Bills Payable Records. 


The Journal having been stripped of cash transactions and purchases 
and sales on credit, may still have numerous transactions through the 
receipt or issue of negotiable instruments, usually promissory notes, in 
liquidation of accounts. These transactions, when numerous, may be 
recorded, at a saving of effort, in special books of original entry. 

The Bills Receivable Book is a register of negotiable instruments 
received, showing date, from whom received, maker, endorser, due date, 
where payable, rate, amount, and such other information as may be of use. 
The name of the person from whom received, usually the maker, indi- 
cates the account to receive credit, and these personal accounts are posted 
from day to day. At the month-end the total of the amount column, 
being the total amount of bills received, is posted to the debit of the Bills 
Receivable Account, thus establishing the equilibrium of the Ledger. 
From a special column in the Cash Book, or otherwise, the total credit 
to the Bills Receivable Account is determined and posted, the balance of 
this account then representing the amount of unpaid bills on hand. 

A special column for cash payments may be provided in the Bills 
Receivable Book, in which case as payments are made they are entered 
opposite the particular item. 


92 


A ruling illustrating the principle is as follows: 





Due Date 


Date | L. F. From Whom Where Rate | Amount |Remarks 


Received $ Endorser Payable 





The Bills Payable Book is a register of negotiable instruments, usually 
promissory notes, given, showing date, to whom given, due date, rate, 
amount, and such other information as may be of use. The individuals 
named are charged, or cash is charged, from day to day as the notes are 
given, and at the month-end the total of the amount column is credited 
to Bills Payable Account. Liquidations are charged to this account, so 
that the credit balance discloses the total notes outstanding. The ruling 
is substantially the same as the one shown for Bills Receivable, although 
it is subject to the needs of the particular business. 

A renewal of a bill receivable should be passed through the records, 
the entry being to debit Bills Receivable and credit Bills Receivable. In 
the Bills Receivable Book the credit is secured by entering it the same as 
a new bill, indicating Bills Receivable instead of a customer’s name, and 
the debit is included in the total posted at the end of the month. In the 
column for remarks the notation ‘“‘ Renewed ”’’ is entered against the renewed 
bill. The same principles apply in the case of the renewal of Bills Payable. 


A Review of the Journal. 


Instead of following the custom of stating, at the outset, that the 
Journal is a book through which opening and closing entries, summary 
entries, and extraordinary entries not coming within the scope of other 
books of entry, are made, and that it must be reserved for such entries, 
it has seemed preferable to reach this point gradually. 

The Journal, in the evolution of Double Entry bookkeeping, has been 
relieved of the transactions resulting from the receipt and payment of 
cash, the purchase and sale of merchandise on credit, and the receipt 
and issue of negotiable instruments, by the use of certain special books of 
original entry. These books have been presented in the probable order 
of their invention, stripping the Journal step by step, until, at this stage, 
it will be apparent why the Journal, in which an entry covering any finan- 
cial transaction may be made, as a matter of fact embraces but few. 





fy Sdehiin 
4 TOSS oa 





x 


THEORY AND PRACTICE OF ACCOUNT Se 
APPLIED ECONOMICS AND ORGANIZATION. 


- By HOMER ST. CLAIR ce eee 
LECTURE VIII. 


CONSIGNMENTS AND SETTLEMENTS. 


De ye ee cr Gu GE Bae 93. 

Pe ACTRESS dS ott ain Wega Phe Oa ae hie (hs ADIT LE Heart IVE Fk a ae O04 
INCIDENTAL CONSIGNMENTS INwARD ON Books Of TRADER......--. 95 

be ALTERNATIVE METHOD Wace Gabe tiie kar ei Ag dG aes COO 

_ ACCOUNT Sates... ae a MN Eats Au UREN Ty ENG e UM rE US ot 99 

pe CONSIGNMENTS INWARD ON Books oF COMMISSION MERCHANTS. 100 
eeMaN TS ae uly ie Sal ye: Ope Ad Bae ate get NU Meas aal a cigs 100 
ALTERNATIVE METHOD......... LAS De tal ee LSM k eit Vea ora 104 

ee ers CURRENT Os. ee a hae ee ee 105 


COPYRIGHT, 1012, BY 
Homer St. CLAIR Pace. | 





THEORY AND PRACTICE OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


Beet OVH RR: ST). CLAIR PACE ©); Pio, 
PEC DUEL: 


CONSIGNMENTS AND SETTLEMENTS. 


Definitions. 


The word consign means to transmit something, by a person known 
as a consignor, to another, known as a consignee, to be held in trust for 
sale or other purpose. That which is consigned is known as the consign= 
ment. In commercial practice the terms are used in connection with 
sending merchandise to an agent or factor, to be sold usually on commis- 
sion. The title of goods remains in the consignor, the factor being intrusted 
with them merely for the purpose of sale. 

A common method of compensating the consignee for his services is 
a commission at an agreed percentage upon the gross selling price of the 
goods. There are other methods of compensation. For example, the con- 
signee may receive for his services the amount secured in excess of a 
stated amount; thus, goods may by billed at a certain price, which is to 
be the basis of settlement in case the goods are sold, the consignee to re- 
ceive for his services any amount that he may obtain in excess thereof. 

The trader whose principal business is handling merchandise on con- 
sisnment is known as a commission merchant. The trader whose prin- 
cipal business is purchases and sales on the ordinary basis may both receive 
and send merchandise on consignment, the receipt being called a consign- 
ment inward and the shipment a consignment outward or shipment. For 
the sake of brevity, it is satisfactory to designate goods received on con- 
signment as consignments, and goods shipped on consignment as shipments. 

A joint adventure is a form of special partnership for carrying on an 
undertaking, not permanent in its character, but involving a special enter- 
prise such as the purchase and sale of a particular lot of merchandise, 
or a speculation in securities. It bears no relation to the subject of con- 


signments, except that a very usual form of joint adventure is the asso- 
Copyright, 1912, by Homer St. Clair Pace 


94 


ciation of two or more persons to purchase and consign merchandise to 
an agent for the purpose of sale. Joint Adventure accounts will be fully 
treated elsewhere. 


Principles. 


During the Middle Ages, the hazards of commerce and transporta- 
tion rendered uncertain the delivery of merchandise and the consummation 
of trades. Therefore, merchandise was sold to a great extent by sending 
it out first upon venture or consignment. The accounting took the form 
of recording the transactions in regard to the particular consignments 
or shipments of merchandise in such a way that their outcome as to profit 
and loss would be disclosed. 

The conditions of trade have changed so that the usual method is 
to make direct sales of merchandise. This takes away the uncertainties 
of the disposal of the merchandise, and the necessity for a knowledge 
of the outcome of the particular shipments. From this change in trading 
practice grows one of the substantial differences between the early and 
the modern practice of accounting, as carried out by the Double Entry 
method. In modern accounting, except in the case of consignments, 
there is no necessity for the maintenance of accounts to show the out- 
come of specific shipments of merchandise. 

Nevertheless, there is still a considerable volume of business trans- 
acted on the consignment basis, and it is interesting to note that in its 
nature it is more or less hazardous, and that, therefore, the old method 
of keeping a record of the outcome of each eonsignment is desirable. This 
is obvious in the produce business, which involves the handling of such 
perishable articles as fruits, vegetables, eggs and butter, and which is 
transacted almost altogether on the commission basis. The trader in 
such produce still declines to assume the risks that would accrue through 
an absolute purchase, and he merely acts as the factor of the producer. 
There are lines of business still conducted on the consignment basis in 
which the uncertainties have been largely removed, but in these cases a 
tendency may be noted to abandon the consignment method. 

The uncertainties incident to the shipment of merchandise upon 
consignment render necessary the distinctive principle of consignment 
accounting, namely, that a record of the financial transactions of each 
consignment, whether sent or received, must be maintained in such a way 
as to disclose its individual status from time to time, and its final out- 
come. To carry this into effect, a number is given to each shipment or 
consignment for the purpose of identification, and the financial trans- 
actions in regard thereto_are recorded_in a distinct ledger account. 


95 | 

The principles underlying the treatment of consignments in accounts 

are the same, whether they constitute the entire business, as in the case 

of the commission merchant, or are merely incidental to the main business, 

as in the case of the trader in the ordinary way. It is intended to set 
forth these principles, and illustrate them with the procedures used. 


Incidental Consignments Inward on Books of Trader. 


Goods received on consignment are accompanied by an invoice stating 
the items, and often the values, which are nominal and do not constitute 
a charge. Upon receipt of the consignment, a memorandum entry should 
be made in the Journal, or in a special Consignment Journal, ruled to 
meet the needs of the business, if the consignments are sufficiently numer- 
ous to justify such a book, giving a number to the consignment for iden- 
tification purposes, and stating the name of the consignor, items received, 
rate of commission, and such other detail as may be necessary to a complete 
record. This is a memorandum entry only, no posting being made. 

The objection may be raised that this does not bring the transaction 
into the Ledger, and that it may, therefore, be overlooked. In properly 
kept memorandum records, this does not follow, and in any event the 
receipt of the merchandise will usually necessitate the payment of such 
expenses as freight and cartage, and this provides an opportunity to bring 
the transaction into the Ledger, and to raise the distinctive account. 

A Ledger account, under the consignment number, as, for example 
Consignment No. 31, is raised, and the expenses incurred through jthe 
receipt of the goods are charged to it. Upon the sale of the goods, Cash, 
if it is a cash sale, or the Debtor, if it is a sale on credit, is charged with 
the selling price, and the Consignment Account is credited. Any further 
expenses, as well as the amount of commission due the consignee for his 
services, are charged to the Consignment Account, and the net credit 
balance of the account is the amount due the consignor. When payment 
is made of the balance due the consignor, as disclosed by the Consignment 
Account, the latter is charged to balance it and Cash is credited. 

In the case of several consignments, or of continuing transactions 
upon the consignment basis, the balances due upon the particular con- 
signments are transferred, when the goods are sold and the balances deter- 
mined, to a general account payable, opened in the name of the consignor, 
and the payments to him are then charged to this account. From this 
ledger account an account current disclosing the debits and credits per- 
taining to the account for a certain period, and the resulting balance, to 
be described more fully later, may be prepared. 


96 


Thus, B received on December 29, 1901, 500 barrels of Merchandise 
X, shipped by A on December 26, 1901, with an invoice value placed at 
$7 per barrel, $3,500, to be sold on a commission of 5 per cent. On the 
date of receipt, December 29, 1901, freight amounting to $465 was paid, 
and on December 30, 1901, cartage amounting to $35 was paid. On Jan- 
uary 9, 300 barrels were sold to Jones & Co. on credit at $10 a barrel, and 
on January to, 200 barrels were sold for cash at $11 a barrel, and an Account 
Sales, to be described later, was rendered. 

The transactions will be journalized to illustrate the accounting 
principles, and, for the sake of simplicity, the cash entries will be included, 
although in practice they would doubtless be passed through the Cash 
Book. The Consignment Account, as set up in the Ledger, will be given, in 
order to show the result of the consignment. The entries and account follow: 


Journal or Consignment Journal: 
DECEMBER, 1901. 
29 
Memo. Entry. 


For this day received from A, 500 barrels of 
Merchandise X, commission 5 per cent., 
being Consignment No. 31. 


Journal (Cash entries included) : 
DECEMBER, 1ogo1. 


29 
CONSIGNMENT NO vBiaat ante tr ee re aes $ 465 
POLCAS Exo tes ner ear a cag Vs ee $ 465. 
For freight, 500 bbls. X. 
30 
CONSIGNMENT.NO. 3iinatar ie fest Be oe 35 
Wo CASH, = ¢.. pcbecemreremencen capes, ts oo 


For cartage, 500 bbls. X 





97 
JANUARY, 1902. 
MOBEES ence Ce lane car 6 ie «a eM as a eae $3,000 


To CONSIGNMENT No. 31 
For 300 bbls. X @ $10 


OP 6) £7 Ho #68 -e 


IO 
eraser, Setar, J5i2 cesily gee aaa Kivsisic' 2,200 
Lo CONSIGNMENT Nowsan wad. tre A 
For 200 bbls. X @ $11 
IO 
MLS VELEN Te N Gat oer a 8 260 


Pet CONMI SOLON ren ele she o's 
For 5% commission on sales of $5,200 


CONSIGNMENT No. 3t. 











Igol 
To Cash, freight...... $ 465 Devitt by Balance a Ver voces 
metas, CALtCAGE « 44. 3: 35 
$ 500 
Ig02 
Maypetances: 224s $ 500 Jan. 9 ee Jones & Co., 300 
‘ Commission, 5%... 260 Dbiss HC Gi $iteatons 
pel la feukes: (9: Sane Geer 4,440 to By Cash, 200 bbls. X 
{Er 39 GER Rate ee 
$5,200 
1902 
[ait kG, oy Dale Ce wee et 


2,200 


260 

















The foregoing Ledger account discloses the balance due A, and would 


be closed by a debit of $4,440 upon settlement or transfer to the personal 
account of A. 


Assuming that the books of B were closed at December 31, 


Igor, 


the debit balance to Consignment No. 31 would be treated as an asset, 


as it is an advance secured by the consignment of merchandise. 


The 


balance of the account would be brought down as indicated, and, on the 


98 


~ 


Balance Sheet, grouped with similar items. The value of the consigned 
merchandise on hand does not appear in the books and would not appear 
in the Balance Sheet. 

If advances of cash were made by B to A before actual sales had been 
made, they would be a charge to the Consignment Account, and the account, 
to the extent of such advances, would be an account receivable. The 
factor may pledge the goods on account of advances to his principal, 
or to reimburse himself for balances due on account. The factor has a 
general lien on goods in his possession for any balances that may be due 
him, that is, he may hold the goods for any balance due on the particular 
consignment, or for balances due on other accounts. 

A running, or open, consignment account is often maintained, on 
which sales are reported monthly and which become an immediate charge 
against the consignee. In sucha case, when the report is not accompanied 
by a check, interest may be allowed by the consignee on the balance of 
the account. 


Alternative Method. 


An alternative method that is not regarded with favor by many 
accountants on account of the extra labor involved, is carried out by 
opening two accounts. By this method, when goods are received upon 
consignment, an entry is made’ charging a distinctive account, as, for 
instance, Consignment Account No. 31, and crediting A, Consignment 
Account, for the invoice value of the goods, with explanation giving a 
description of the goods, stating the commission to be allowed, and other 
necessary detail. The price received for the goods is credited to Consign- 
ment Account No. 31 as and when sales are made. The balance of the 
account, when the goods are entirely sold, is the excess of selling price 
Over inventory value of the goods, and is transferred to A, Consignment 
Account, by a charge to Consignment Account No. 31, and a credit to 
the former. This amounts merely to a trading account covering the 
goods consigned. 

A, Consignment Account, which, in the meantime, has been charged 
with freight and other expenses chargeable to the consignment, is charged 
with the agreed commission, and the balance to the credit of the account 
is the amount due A. When the indebtedness of A is liquidated, the 
account is charged to balance. 

The argument advanced against this method, aside from the extra 
labor involved, is that, inasmuch as there was never any real liability to 
the consignor, such liability should not be shown in the accounts. The 
lability, however, is nothing more than a consignment, or goods, liability, 
and is so shown in the caption of the account and is offset by the asset 


99 


set up contra.’ The first’method is accepted as the better’ practice, and 
the second method is explained mereiy for the purpose’ of informing’ the 
student as to the alternative procedure. 


Account Sales. i 


An Account Sales is a statement disclosing transactions incident 
to a consignment, and is rendered by the consignee to the consignor. The 
items of merchandise sold, and the prices received therefor, are stated, 
the total receipts constituting the gross charge to the consignee. The 
amount of the freight and other expenses inourred, as well as the agreed 
commission, are deducted, the remainder being the net amount for which 
the consignee accounts. Unsold merchandise is shown on the Account 
Sales as a memorandum, usually at the foot of the statement. An Account 
Sales, prepared in the usual form, to cover the transactions before given, 
would be as follows: 


B, COMMISSION MERCHANT. 





ACCOUNT SALES of 500 bbls. X, received December 29, 1901, from, 
and sold by order of, and for account of, A: 


1902 
Meum 200 DDISX () O10, ee ee $3,000 
eC isae (Oeil mes or. Pe SIN Oe, 2,200 
——_——_ $5,200 
Less Charges: 
SSRIS Gu chelate bie tea Nase! alae: $ 465 
tefaig Lag 2G Ae ERS alee i ng ion ee ete 35 
CRM ISSHOM Rater Eee Ti oe Ts 260 
760 
Net Proceeds Due........ $4,440 


The form of the Account Sales may differ from the above. For 
example, the word By may precede the sales, and the word To the charges, 
and in the case of the Account Sales covering different classes of merchan- 
dise, with numerous sales, a column may be provided for each class, and 
the total carried out to obtain the total proceeds of sales. It may also be 
set up in account form, as a transcript of the Ledger account. 


100 


Consignments Inward on Books of Commission Merchants. 


The accounts necessary to record consignments when handled by a 
commission merchant do not differ essentially from those used when the 
handling of consignments is incidental. The approved procedure is to 
treat the merchandise received in memorandum records until actual finan- 
cial transactions take place. To illustrate the application of the prin- 
ciples, the methods of a concern selling cloth upon commission will be 
considered. 

The consignments received are entered, upon notice from the receiv- 
ing department, in what is known as an Invoice Book, providing columns 
for date, case number, style number, yards, and the name of the mill from 
which the consignment is received, a page or number of pages being given 
to each consignor. This is in the nature of a memorandum book and 
forms no part of the double entry system. 

A Sales Book is maintained with columns for date, name of customer, 
ledger folio, and total amount sold. In addition, distribution columns 
are provided, one for each consignor or mill whose product is handled. 

Upon receipt of notice from the shipping department that a certain 
lot has been sold and shipped, a note to that effect is made in the Invoice 
Book against the original entry. An entry is made in the Sales Book 
charging the customer and crediting the consignor or mill for whose account 
the sale is made in the column provided for that purpose. At the end 
of the month, the total sold for each consignor, as disclosed by his column 
in the Sales Book, is credited to his account. 

It is customary to render an Account Sales to each mill weekly from 
the facts recorded in the columns of the Sales Book. At the end of the 
month, a statement, recapitulating the Account Sales, is rendered, de- 
ducting returns, thus showing the net sales. The charges incurred, which 
have been“charged to the consignor’s account as paid, are deducted, as 
well as the commissions earned, the balance showing the net amount 
due the consignor, as disclosed by his account. 

It will be understood that the consignor’s account is credited from 
the Sales Book, and is charged with expenses, and when the commissions 
are charged at the end of the month, the balance discloses the amount 
due. The unchecked items in the Invoice Book will constitute the con- 
signments on hand. 


Shipments. 


The shipment of goods by the consignor, that results in the consign- 
ment inwards with the consignee, requires treatment on the books of the 
consignor. The desirability of keeping the record so that the outcome 


IOI 


of each shipment may be known, leads, in the usual practice, to an imme- 
diate transfer of the cost value of the goods shipped to a distinctive ship- 
ment account in the Ledger, numbered for the purpose of identification. 
This is in contradistinction to the memorandum treatment used in con- 
signments inward until financial transactions take place, although in 
some cases, as will be explained later, the memorandum method is desir- 
able in the case of shipments. 

The most usual procedure in recording shipments is to raise a Ship- 
ment Account, with a distinctive number, at the time the goods are shipped, 
in the General Ledger, or in a special Consignment Ledger, to hold all 
such accounts, if the shipments are numerous enough to warrant such 
a book, to which the cost value of the merchandise consigned is charged. 
Theoretically, the raising of the Shipment Account is the transfer to it of 
the cost value of the merchandise from the account to which it was charged 
in the first place. In case a Merchandise Account is maintained, the 
credit would naturally have to be made to that account, although confus- 
ing the cost value of the goods consigned with the credits to the account 
by reason of sales is an undesirable procedure, as, in fact, is the entire 
method of using a Merchandise Account. 

In case the more modern method of keeping the purchases and sales 
in distinct accounts is used, the credit can be immediately made to the 
Purchases Account, although this would impair the statistical value of 
that account, for the reason that its balance would not disclose either 
the gross or the net purchases. 

Another method, that obviates some of the undesirable features of 
the others, is to raise a Consignments Account to which the cost value of 
all merchandise placed upon consignment during the accounting period is 
credited, the balance of which during the accounting period will, therefore, 
disclose the cost value of goods shipped on consignment. | 

If the latter method is used, the entry upon placing the goods upon 
consignment would be a charge to, say, Shipment Account No. to, and 
a credit to Consignments Account, at the cost value of the goods shipped. 
Any charges, such as freight and cartage incurred in placing the goods upon 
consignment, are chargeable to the Shipment Account, and in accounting 
practice are entitled to rank as an addition to the asset value of the goods 
on consignment. The credits for such charges would be made to Cash 
or to the proper creditor, and would, of course, not affect, in any way, 
the Consignments Account. 

Upon receipt of an account sales from the consignee, an entry is made 
charging the consignee, if the account is not settled, or charging Cash or 
Bills Receivable, if it is settled by cash or bill, with the net proceeds, 


10g 


and crediting the Shipment Account. As an explanation to the entry, it 
is well to state the details of charges, and commission of the consignee, 
as disclosed by the account sales. If the entire amount of goods on the 
particular shipment is sold, and the procedure outlined carried out, the 
Shipment Account will disclose the net profit or loss on the shipment, to 
be carried to the Trading Account or Profit & Loss Account at the time 
of closing the books. 

The procedure will be illustrated by using the transactions given in 
the Consignment of A to B. The transactions will be journalized, includ- 
ing cash entries, and the Shipment Account, Consignments Account, and 
Personal Account of B, set up. 


Journal: 
DECEMBER, toot. 


26 


For consigned B, 500 bbls. X, to be sold upon 
5% commission. 


JANUARY, 1902. 
13 


To ‘SHIPMENT No? ‘Ter. naw. ieee 4,440 
Por'sold:"-300 bis. Ao (@ $10.0) ee $3,000 
BOO MDISAEA (OIL. ae oe 2,200 


Less Charges: $5,200 
Freiont:. 4 A vaiitis $465 
Cartage tices at uke 35 
Commission 5%.... 260 





760 


$4,440 


103 


Ledger: 
SHIPMENT No. to. 
IgoI IgoI . 
Dec. 26 To Consignments..... $3,500 Decsear by Balances, 6 Urry. $3,500 
1902 | 1902 > 
Wena to: Balance...) 0)... $3,500 AEE rt an hice be Paes Ben a Ee eR ee $4,440 
Wee lance sath et 940 
$4,440 $4,440 
1g02 
Jan. 13 By Balance (profit)... $940 


CONSIGNMENTS. 


IQOI 


' Dec. 26 By Shipment No. 10.. $3,500 


Ig02 
Jan. 13 ToShipment No. 10.. $4,440 


Assuming that the books were closed at December 31, 1901, the 
debit balance to Shipment No. 10, $3,500, being the cost value of goods 
shipped upon consignment, would be treated as an asset. On the Balance 
Sheet, it would be stated as inventory upon consignment. Had expendi- 
tures such as freight and cartage been incurred in placing the goods upon 
consignment, it would be allowable to charge them to the Shipment Account 
and treat the combined amount of inventory value and such expenditures 
as asset value. 

The balance to the Consignments Account, being an amount withheld 
from the credit side of the Merchandise Account, or the Purchase Account, 
for the reasons stated, may be credited to either, or to a trading account. 
That this is correct in principle may be seen from the fact that in the 
case given, it is merely inventory, and that this is, in effect, the same as 
is done with the inventory of merchandise not placed on consignment. 


104 


That it would be correct, in case the goods have been sold, to credit 
it likewise, may be seen from the fact that it represents cost of goods 
sold, withheld for the time being from the Merchandise Account or Sales 
Account. In connection with profit or loss, to be transferred from the 
shipment account, it would give the element of sales. 

Thus, the entire amount standing to the credit of Consignments 
Account at the end of the accounting period, representing cost of goods 
sold on consignment and cost of inventory on consignment, may be credited 
to Merchandise Account or Trading Account, whichever is used. An 
analysis between the two elements may be made if desirable, and the 
cost of goods sold may be combined with the results transferred from the 
shipment accounts to determine the net selling price of goods sold on 
consignment, if such course is desirable. 

In any event, merchandise consigned must not be treated as sales 
at least until actual sales are made and it passes from the consignment 
status. 

Alternative Method. 

An alternative method is based upon the theory that a shipment of 
merchandise upon consignment amounts merely to a transfer of stock 
from warehouse to the possession of the consignee, and requires no entry 
other than a memorandum record of such transfer until financial trans- 
actions actually take place. For the purpose of making the memorandum 
record, a Shipments Book is maintained, in which a record is made of 
the lots of merchandise sent out upon shipment, giving a distinctive number 
to each shipment and details of goods shipped. In case many shipments 
are made to one consignee, it is sometimes desirable to allot a special page 
in the Shipments Book to such consignee. As the shipments are sold 
and account sales received, they are checked from the Shipments Book, 
so that an inspection of this book, if properly kept, will disclose the stock 
out on shipment. Especial care is necessary in keeping such a book, for 
inthe absence of the necessity of making it prove with other records, 
the entries may be carelessly made. It answers its purpose well enough 
if properly kept. In the case that shipments are so rare that a special 
Shipments Book is not justified, a memorandum Journal entry may be 
made in the same manner as was suggested to record the receipt of con- 
signments inward. 

Upon receipt of an account sales covering a shipment, entries are 
passed, charging the consignee with the net proceeds, and crediting the 
amount to a Sales Account, or to Merchandise Account if the latter is 
kept. It would be practicable to credit such amounts to a Shipment 
sales Account, to be transferred to the Trading Account at the end of 


105 


\ 


the period, if it were desirable to make the segregation between sales 
on shipments and sales on the ordinary basis. 

If charges were prepaid on shipments, they could be charged to a 
general account called Freight and Shipments. At the end of the 
accounting period, this account would be analyzed, and- the charges on 
outstanding shipments would be retained as a deferred charge or asset to 
be added to the amount of the merchandise on shipment, and the nomi- 
nal portion would be carried as a charge to the Sales Account, or to the 
Shipment Sales Account if the latter is maintained. It will be noted that 
in this procedure, for the sake of brevity, the distinctive principle of a 
ledger account for each shipment is omitted. Reliance is had upon the 
account sales and other detached papers for information as to the outcome 
of the particular shipment. 

For inventory purposes the unchecked items in the Shipments Book 
disclose the goods on shipment to be taken into stock. The amount would 
be charged to Inventory on Shipments, and credited to the Trading Ac- 
count or Merchandise Account if the latter is maintained, the same as 
other inventory. On the Balance Sheet of the consignor, it would ap- 
pear as Inventory upon Shipment. 

The successful use of this alternative method depends almost en- 
tirely upon the correct handling of the memorandum records covering 
the shipments. The method first given would probably give the better 
results under ordinary circumstances. 

Accounts Current. 

Credit transactions involve, for the purpose of verification and agree 
ment, the exchange of written documents or statements, of which the 
invoice, bill, statement, and account sales, that have been sufficiently 
described in this and previous lectures, are types. Another common 
form heretofore referred to, and one that may be described conveniently 
at this juncture, is known as an Account Current. 

An Account Current is usually a transcript of a ledger account, dis- 
closing the charges that have been made to an individual, firm or corpora- 
tion, for a certain period of time, and the credits that are proper offsets 
to such charges. The account is usually brought to a balance, which 
if a debit, measures the amount receivable on the account, and if a credit, 
the amount payable on the account. The term open account is often used 
as synonymous with account current, either describing a statement that 
discloses a series of charges and credits between two parties, that is still 
continuing. 

An Account Stated is an account rendered to which the parties have 
expressly or impliedly agreed. To maintain an action upon an account 
stated, it has been held that it must appear that the account has been 


106 


balanced and rendered, with an assent on the part of the defendant, either 
express or impled, to the balance. The acceptance of an account ren- 
dered, without objection within a reasonable time, will render it an account 
stated, and it will not be necessary to prove the items that result in the 
balance. In the case of fraud or mistake, such an account may be im- 
peached, but not otherwise. It will be seen from the foregoing that an 
account current, when it is agreed upon, becomes an account stated. 
This may come through lapse of time, without objection on the part of 
the one to whom the account is rendered, although the better and more 
usual course is to accept the account and thus make it an account stated 
beyond question. 

In the absence of interest charges or allowances upon the items of 
an open account, the rendering of an Account Current amounts to nothing 
more than transcribing the debit and credit amounts and bringing down 
the resultant balance. In many lines of business, however, by express 
agreement or trade custom, the equities of the parties are conserved by 
the calculation of interest upon the debit and credit items that enter into 
an account current. Thus, if a factor, credited the account of his prin- 
cipal with the proceeds of the sales of various lots of merchandise during 
the month, but did not remit for the same until a subsequent date, the 
principal might be compensated. for the loss of the use of the proceeds 
by interest calculated upon the various amounts from their respective 
dates to the subsequent date of settlement. 

If a payment were made on account during the interval thus covered, 
the interest upon such payment, from its date to the subsequent time of 
settlement, would be deducted from the interest upon the credits to the 
account of the principal, to arrive at the net interest charge that should 
be made against the factor. 

There are several ways in which the interest may be calculated. The 
method that has been indicated is to compute interest at the agreed rate 
upon each debit item from its date until the desired subsequent date, and 
upon each credit item from its date until the desired subsequent date. If 
the interest on the credit items is greater than the interest on the debit 
items, such excess is the net amount of interest to be credited to the 
account; if the interest on the debit items exceeds the interest on the 
credit items, such excess is the net amount of interest to be charged to 
the account. 

In rendering the account, it is usual to provide two extra columns 
on the debit side, one to contain the number of days for which interest 
is to be calculated for the particular item, and the other to contain the 
amount of such interest. #For the same purpose, two columns are added 
on the credit side. 


107 


The difference between the interest columns will indicate a net credit 
or charge on account of interest as the excess may be a credit or debit 
ba’ance. The difference is carried to the interest column contra to bal- 
ance, and is also carried to the regular debit money column, if a charge, 
or to the regular credit money column, if a credit. This is the method 
used in many lines of business, including stock brokerage. 

The method will be readily apparent from the following illustration: 
HENRY SMITH 


in account with 

















Dr. July, 1902. CARLING & CO., Factors. Cri 
Date Item Amount | Time|Interest|} Date Item Amount | Time|Interest 
(d’ys)| (6 %) (d’ys)| (6 %) 
1902 1902 
aves SU OLCASH 2. arsis csc ces $2,000.00] 8 $2.67]! July 1|/By Account Sales ...| $1,000.00} 30 $5.00 
ies CUM et... ss) acl F,000.00| x E27 Miwa eek |e a fee tel 215O00.00|—) 12k 8.75 
uly ati io interest, 6%, conira|.........|..... 14.41 Sor siles “ aye 500.00] 18 I.50 
SEan|OMbGLINCe GOWN... .| 1,814.41]. .06 |. cee oss Pe tTEO| tone a: ce BO 800.00] 15 2.00 
‘** 31] ‘* Interest, net credit 
COMUTA ci seesnem ss). EACA Ee apart: 
$4,814.41 $17.25 $4,814.41 $17.25 
- 1902 
| Aug. s\ By. Balance: (2 -; 255), $1,814.41 


Another method of arriving at the net charge or credit on account of 
interest is to determine the balance of the account from day to day, and 
calculate the actual interest upon such balance for the time that it exists. 
This is particularly useful where the balance is a matter of continual in- 
terest, and is likely to remain either a debit or credit balance steadily. It 
makes no difference in the result, of course, whether interest be calculated 
on the total debit and credit items, and the difference taken, or whether 
the difference between the debits and credits be determined and the in- 
terest calculated thereon. The procedure will be clear from the treatment 
according to this method of the facts before given. It is as follows: 


HENRY SMITH 
in account with 


July, 1902 CARLING & CO., Factors. 

Date Item Dr Cr. Balance | Days | Interest 

6 % 

1902 Cr. Cr. 
Jaiernemy Account Sales... ........ $1,000.00] $1,000.00 9 $1.50 
Wek FEOV as vs Pee osrhe ear a bl as Diese aioe Ser ala: sl 2,500.00 3,500.00 3 1.75 
Cort St Cae rt ROUGE vie ei yas aka ees 500.00 4,000.00 3 2.00 
aia yo hy . Pe OAs ie Cara eaks (mar tet iin, sane 800.00 4,800.00 7 5.60 
ene Se WESC TASTES sai a's nies ww cee ws $2, 000100ls- a meee: 2,800.00 7 3.26 
MME UPI MRS TGs: he oie eso. 9 ee ees © TOOO0O le Re eetnae 1,800.00 I .30 
ST IB VELMECTCS., O57. oc cave cr os Eiye tieee Pac AP ite ase ha dPdiveat oc 5 $14.41 
(EEN) SETS 11st a a a EOS EAL AEP er ten eee tesa hy AT tu cn 2 chile Sex ty 
$4, SIA ATI OA rObAtA Tier et awe ers ee $14.41 


RRR TS AS AIATIO®, Con irie Gig yy state copie S ew Ret ee Ss SRSA ANGE OLAAT Soak sil S poe ge 


108 


The rulings in bank ledgers proceed upon the plan of the last state- 
ment, in order that the balance of the account, which is a matter of vital 
interest, may be disclosed from day to day. In case of the allowance of 
interest upon a depositor’s balance, the interest, in ordinary practice is 
not credited from day to day, but is calculated periodically, say once a 
month or once a quarter. Referring to the illustration, interest on $1,000 
for 9 days would equal interest on $9,000 for one day. Multiplying by 
the number of days, the following is obtained: 


9 x $1,000 =e $9,000 
2 * 3,500 — 10, 500 
3 x 4,000 <= 12,000 
7 “8 4,800 = 33,600 
7 x 2,800 = 19,600 
I x 1,800 a 1,800 

LOtaL. ..-bapmale eee ahs $86, 500 


This is the amount, $86,500, wpon which interest must be calculated 
for one day. Pointing off two places gives $865, interest at 6 per cent. 
for 60 days, and dividing by 60, to obtain interest for one day, gives the 
same result as obtained in the illustration, viz.: $14.41. 

In practice the banks calculate on the even hundreds. This would 
take two places off each product, and off the total, so that the total could 
be divided by 60, or, still shorter, disregard the cipher on the 60, point 
off one place, and divide by 6. Taking the figures above, leaving off the 
two places, gives 865; pointing off one place, gives 86.5, and dividing by 
6, gives result, $14.41. 

In case the balances change frequently, the multiplication may be 
avoided by carrying out the balance for each day and adding to obtain 
the amount on which to calculate interest for one day. If the balance for 
g days is $1,000, the same result is obtained by carrying out the $1,000 
nine times and adding, as by multiplying $1,000 by 9. This is the more 
usual course in case the balances are subject to frequent changes. 





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THEORY AND PRACTICE OF ACCOUNTS. 
: | APPLIED ECONOMICS AND ORGANIZATION. 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


LECTURE? LX: 


THE LEDGER AND CONTROLLING ACCOUNTS. 


Popes a vecOnmner. 3k Oca anor eo ae ce 109 
Po emaiatiinns AGCOUNTS. ore viele et eee AEE: 
Customers’ CONTROLLING ACCOUNT..... 00. 0c ccs ceeeseenes Weta. 111 
_. CrEpITorRs’ CONmROLLING ACCOUNT: 3 kee s ace ne dA dl3 
ee MeO Ks) rte Sea MIN rh aR cS a 116 
THE ADVANTAGES...... Pde UA He RUN PENN See me I ON LE ew od 118 
Bee anos Vnocers eo Oe wes 119 
Pe EIGER se aR Nee UR UE APE Goi cael 120 
a RAMSACIONS JIURING ACCOUNTING PERIOD.) Osh ol ode ese Roos 122 


Seen TRING se? FT Is OF CLOSING BOOKS. MeO ye ree 122 


COPYRIGHT, 1914, BY 
Homer St. Craik Pace. > 


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Pmt : ‘ 





THEORY AND PRACTICE OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) _ 
LECTURE IX, 
THE LEDGER AND CONTROLLING ACCOUNTS. 


Ledger Development. 

The use of a single Ledger would, under usual conditions, be clumsy 
and unsatisfactory in a business large enough to justify the use of the 
modern columnar books of original entry that have been described in 
previous lectures. Therefore, it is necessary to consider more particu- 
larly the Ledger, its development, and its adaptation to the requirements 
of modern accounting in an undertaking of considerable size. 

In a small business, where the accounts may be conveniently carried 
and handled in a single Ledger, it is usual and satisfactory to group the 
accounts in the Ledger into three divisions according to their nature, 
viz., Real Accounts, Nominal Accounts and Personal Accounts. Thus 
pages from 1 to 100 might be allotted to Real Accounts, from 101 to 200 
to Nominal Accounts, and from 201 to 500 to Personal Accounts. The 
Personal Accounts should be subdivided into Accounts Receivable and 
Accounts Payable. The classification is often, deviated from and the Cap- 
ital and Drawing accounts of the proprietor, or partners, stated first, and 
the location of Nominal Accounts and Personal Accounts may be reversed. 

The classification indicated is useful in posting and in referring to 
the accounts, as the nature of the account indicates approximately its 
location in the Ledger. It also permits of a convenient grouping of the 
accounts in the trial balance that is useful in studying the condition of 
the accounts, and in the preparation of statements. 

When the volume of business is so large that the one Ledger is inade- 
quate, additional ledgers are added, but the division of accounts as between 
the different ledgers does not ordinarily follow, as in the single Ledger, 
the classes of Ledger accounts. In the first stage of development beyond 
the single Ledger a division is made into three ledgers, as follows: 

1. Customers’ Ledger, or, as it is often called, Sales Ledger, 
designed to contain the accounts of those who are indebted to the under- 


taking, including, it may be, Bills Receivable. 
Copyright, 1914, by Homer St. Clair Pace. 


110 


2. Creditors’ Ledger, or, as it is often called, Purchase Ledger, 
designed to contain the accounts of those to whom the undertaking is 
indebted, including, it may be, Bills Payable. 

3. General Ledger, designed to contain all of the accounts pertain- 
ing to the undertaking that do not fall within the scope of the Customers’ 
Ledger or the Creditors’ Ledger. 

If the volume of business justifies it, there may be a still further 
division of the Customers’ Ledger or the Creditors’ Ledger, either alpha- 
betically or geographically. Thus, the accounts receivable may be divided 
into two ledgers, one containing those accounts beginning with the let- 
ters from A to M, and the other those from N to Z; or, geographically, 
one ledger may contain accounts with city customers, the other, accounts 
with out-of-town customers. 

It is often desirable that the financial position and earning capacity 
of the undertaking may not be common knowledge among the office em- 
ployees, and to guard against such a contingency the General Ledger may 
be divided into a Private Ledger, containing the Real Accounts, Capital 
Account and the Profit & Loss Account, and a General Ledger, contain- 
ing the other ledger accounts. The Private Ledger is usually in charge 
of the proprietor, a partner, a confidential clerk, or the firm’s accoun- 
tant. Instead of thus dividing the General Ledger, some firms prefer to 
treat the General Ledger itself as a private book, to be kept by one in 
the confidence of the management. The use of the Private Ledger will 
be more fully considered later. 

While there may thus be three or more ledgers, it is evident that 
each contains but a part of the accounts which, to obtain a Trial Balance, 
must be considered as a whole, and which, in the small undertaking, are 
contained in a single Ledger. 

The location of an error, in an attempt to arrive at a trial balance 
from the books of a business so small that the accounts can be handled 
conveniently in one ledger, is not a serious matter, but considerable labor 
is involved in checking over accounts numerous enough to justify the use 
of three or more ledgers. 

The work is further complicated by the fact that, in the larger under- 
takings, several bookkeepers are employed on the accounts. Without 
special provision in the methods used, the error cannot be localized, in 
advance, to a particular ledger and assigned to the bookkeeper in charge 
thereof, but a general checking of the ledgers must be instituted. 

To secure this localization of error in advance, and for other import- 
ant reasons that will appear, Controlling Accounts, sometimes called 
Adjustment Accounts or Summary Accounts, have been devised. 


111 


Controlling Accounts. 


In a system of accounts that embraces Controlling accounts, there 
is one Ledger, usually the General Ledger, that has within it all of the 
elements necessary to effect a Trial Balance. ; 

Within it are not only the ordinary detailed accounts that fall within 
its scope, but in addition controlling or summary accounts that disclose, 
in summary form, by reason of monthly postings, the transactions that 
are posted in detail from day to day in subsidiary ledgers. 

Thus, there may be a Customers’ Controlling Account that discloses, 
by its balance, the total amount due from customers. The individual 
accounts with customers are kept in a Customers’, or Sales, Ledger, and 
the debit balances in that ledger, in the aggregate, exactly equal the debit 
balance of the Customers’ Controlling Account in the General Ledger. 

Likewise, there may be a Creditors’ Controlling Account, the credit 
balance of which exactly equals the total credits of the individual ac- 
counts with creditors in the Creditors’, or Purchase, Ledger. 

- The manner of bringing this about is worthy of careful study, for 
the principle is one of great importance in the modern development of 
accounting. The principle will be illustrated with customers’ and cred- 
itors’ controlling accounts, although its application may be extended to 
the control of factory accounts by the general financial books, the control 
of the receipt and issue of stores, the control of departments and tax levies 
in municipal accounts, and, in fact, to innumerable conditions throughout 
accounting. 

aay 4 Customer’s Controlling Account. 

To open a Customers’ Controlling Account in the General Ledger, 
after a trial balance is effected to insure accuracy, the sum of the debit 
balances of individual customers’ accounts is charged to it, and the indi- 
vidual accounts are credited and thus closed out. This may be done 
by a Journal entry. The individual accounts are then opened in the 
Customers’ Ledger, the Journal entry supplying the information in proved 
and convenient form. If it were the original opening of the books, the 
credit would be to Capital. 

An illustrative skeleton Journal entry is as follows: 

CUSTOMERS’ CONTROLLING ACCOUNT To SUNDRIES 

For opening of controlling account, and closing of 
individual customers’ accounts, as under: 
cy (Stig Cd a Ube ORR Or RO ek SSO Re Saha ea 
reve Stem imme OVO Sete he! AS SO AS IO. PEA Se, 


MOO ses 6 Fe) 876 Oe LS en elle) eo 8. ee 6 a & a een 6 6. 6a we 


112 


The controlling account is usually brought to its true state by sum- 
mary entries at month-ends, preferably passed through the Journal. 

The sales, for example, are recorded from day to day in the Sales 
Book, and the charges are made to the individual customers’ accounts in 
the Customers’ Ledger, so that, in connection with entries posted from 
other books of original entry, the state of a customer’s account may be 
determined at any time. The total sales for the month, as disclosed by 
the summation of the Total column in the Sales Book, is charged by 
Journal entry to Customers’ Controlling Account, and credited to Sales 
Account, the credit being the same as would take place were no control- 
ling account used. It will be clear that this amounts, in the General 
Ledger, to posting the total charges in one amount to a controlling, or 
summary, account, the individual debits having been made in a sub- 
sidiary ledger. 

An illustrative entry is as follows: 

CUSTOMERS’ CONTROLLING ACCOUNT........ 
Ta. SALES: 3h See Gai Re Se 

In case of returned sales, the procedure would be the inverse of that 
carried out to record the sale of the goods. 

In the Cash Book, provision is made on the debit side for a Net Cash 
column, a Discount column, and a Customers’ column, the latter, in case 
of a payment under discount, containing the total of the first two. Thus, 
upon receipt of $99 from a customer in payment of an account of $100 
under one per cent. discount, the $99 is entered in the Net Cash column, 
the $1 in the Discount column, and the $100 in the Customers’ column. 
~The customer is immediately credited in his account in the Customers’ 
Ledger with the $100. The totals of the Cash and Discount columns 
are available at the month-end for summary entries, Cash and Discount 
being charged and Customers’ Controlling Account being credited. 

An entry to illustrate the principle is as follows: 

SUNDRIES To CUSTOMERS’ CONTROLLING ACCOUNT 


DISCOUNT sic cc ashe ec 0 9 eign se 0 it re ls 

If a Bills Receivable Book is kept, the bills will be entered from day 
to day, and the accounts of the respective customers, from whom the bills 
are received, will be credited in the Customers’ Ledger. At the end of the 
month, a summary entry is passed, charging Bills Receivable Account, 
kept in the General Ledger, and crediting Customers’ Controlling Account, 
with the total of the notes received from customers during the month. 

In case a Bills Receivable Book is not kept, the bills will be entered 
in the Journal. Bills Receivable account will be debited, and the cus- 


113 


tomer’s account, kept in the Customers’ Ledger, will be credited for each 
transaction. Therefore, for the summary entry at the end of the month, 
it will be necessary to determine the total amount of such entries from 
the Journal, and debit Bills Receivable account with it. The amount is 
ticked off without posting, it being noted that the entries have already 
been posted in detail to Bills Receivable Account. Customers’ Control- 
ling Account is credited to balance the amount of the debit. 
The entry would be: 
Peeler OL V ADL, ) >) eee tees ee ele ews 
To CUSTOMERS’ CONTROLLING ACCOUNT 
The Customers’ Controlling Account would then disclose the trans- 
actions with customers in summary form. Assuming figures for the pur- 
pose of illustration, the procedure will be made clear from the following 
form of account: 

















Dr. CUSTOMERS’ CONTROLLING ACCOUNT. Ce 
1902 1902 
Jan. 1 To Balance (total due Jan. 31 By Cash & Discount 
from customers)....... $20,750 (total for month)...... $17,100 
2/31 *To’ Sales (total for “31 By Bills Receivable (to- 
Sremittiae. SoS er Se 24,125 tal for month)......... 900 
SO Slo By Balance. As. Sa 26,875 
$44,875 $44,875 
Feb. 1 To Balance (total due 
from Customers)...... $26,875 


It will be apparent that, if the Customers’ Ledger is properly opened, 
so that, at January 1, 1902, the debit balances of the accounts equal the 
balance shown in the Controlling Account, and the totals have been prop- 
erly taken off, entered and posted, the combined balances of the custom- 
ers’ accounts must be brought to an absolute agreement with the Con- 
trolling Account. If an error, therefore, has been made in posting to a 
customers’ account it is immediately localized by the failure of the Cus- 
tomers’ Ledger to prove, and the searching of the remainder of the ac- 
counts for the error is avoided. 


Creditors’ Controlling Account. 

The Creditors’ Controlling Account is opened by a credit to it of 
the total amount due to creditors, as disclosed by the books when their 
accuracy is determined by a trial balance, and the individual creditors’ 
accounts in the General Ledger are debited to close them. The individual 
accounts with the creditors are then opened in the Creditors’ Ledger. 


114 


The information for this latter procedure may be obtained from the 
Journal entry if a Journal entry is used as, in many cases, is preferable. 
The following entry illustrates the principle: 


SUNDRIES To CREDITORS’ CONTROLLING ACCOUNT 
For opening of controlling account and closing of 
individual creditors’ accounts, as under: 
DAVIS Fe CO or re a iia ae ae 2 ae or cig pape 
JAMES BROS. eo. ocelot bye oe 6 On Geek oe 
B.) .G.. SEARLE) 633 c2b.00 4s CGE BG 2S - oe 
ET C5 TCs 2s feisapd » appcegset uneleh lcets bok? © « Wiela pile 


It wili be seen that this amounts to a consolidation of the accounts 
payable into one account in the General Ledger, and the opening of a 
subsidiary ledger for the individual accounts. 

As in the case of the accounts with customers, if the total credits 
and the total debits thereafter entered in the individual accounts are 
carried to the respective credit and debit side of the Creditors’ Control- 
ling Account, its balance will equal the combined balances of the sub- 
sidiary ledger. 

A record of the purchases will be kept in a Purchases Book, or similar 
record, from day to day, and from it the creditors will be credited with 
their respective amounts in the individual accounts maintained in the 
Creditors’ Ledger. 

From the Purchases Book the total purchases for the month may be 
ascertained at the month-end, and a summary entry passed in the Journal, 
charging Purchases, Plant, Expense, or such other accounts as may be 
indicated by the columnar arrangement of the Purchases Book, and credit- 
ing Creditors’ Controlling Account. 

The following entry illustrates the principle: 


SUNDRIES To CREDITORS’ CONTROLLING ACCOUNT 
For purchases, etc., for month of.......... as under: 
PURCHASES coi v oe ae te bc crcels areie 4a ype oe 
EX PENS Be ois cis aces bu gy eee a EEL OE aha inl cas fae 


On the credit side of the Cash Book columns are provided for Net 
Cash, Discount, and Creditors, so that in case of a settlement of a claim 
for $200 under two per cent. discount, $196 is entered in the Net Cash 
column, $4 in the Discount column, and the $200, being the amount charge- 
able to the creditor in his account, is entered in the Creditors’ column: 
The totals of these columns are available for a summary entry at the month- 
end, Creditors’ Controlling Account being charged with the total charged 


he 


to the various creditors’ accounts, as shown by the Creditors’ column, 
and Cash Account and Discount Account being credited to balance, thus: 


CREDITORS’ CONTROLLING ACCOUNT To SUNDRIES 
PSCOUNT Ir? 88 Oo “igictdl Bee mucins) Bah prorins 


wee OL 6 Ole 161.6) 8 60 618 OP 6 6 8 Re 6. CAO ESS Om ©). 6) 04 6) 6) 8 ek & 61 28 6 87,846) @ OY 6 


If settlements were made with creditors by giving them Bills Payable, 
and such Bills Payable were debited to the proper creditors’ accounts 
in the Creditors’ Ledger, and credited to Bills Payable Account in the 
General Ledger, by Journal entries, it would be necessary at the month- 
end to pass a summary Journal entry, debiting Creditors’ Controlling 
Account and crediting Bills Payable (noting that the latter had already 
been posted), with the amount, posting only the former. If a Bills Pay- 
able book were maintained, the total credit on account of bills issued 
would be ascertained from this book, and would not have been posted 
during the month, as would be the case were the Journal method used. 

The entry would be: 


Pm lORS’ CONTROLLING ACCOUNT. ws. ute os 
EDT DIST RIA", Wo 4 Of ser ge roe Rea a are aR eee pee A 


The amount of Returned Purchases would be debited, by a summary 
Journal entry, to Creditors’ Controlling Account, and Purchases would be 
credited, thus: 


CREDITORS’ CONTROLLING ACCOUNT................. 
RACER GETA SEG, MOET TORE RN ork? OY SITCIIOO 


In short, the procedure in the case of creditors’ accounts is the in- 
verse of that adopted in the case of customers’ accounts. 

The procedure will be more easily understood, perhaps, by a study 
of the following illustration, which is drawn up to conform to the prin- 
ciples and practice set forth: 


Dr. CREDITORS’ CONTROLLING ACCOUNT. Cr 
1902 1902 
Jan. 31 To Cash & Discount (to- Jan. 1 By Balance (total due 
tal for month).....2... $11,500 th @reditors) 2ic5. 4a ese $10,800 
“31 To Bills Payable (total “31 By Purchases (total for 
fo nonth aioe hi, 800 MONCH es te ee ee 
“31 To Returned Purchases 
(total for month)...... 250 
alee Lo balance)... 20).5. \. 10,250 











$22,800 $22,800 


Feb. 1 By Balance (total due 
Creditors) seuss Fah. $10,250 





116 


The monthly entries may be made by postings direct to the Ledger 
accounts from the books of original entry, as is done by many bookkeepers, 
although there is more likelihood of errors, due to omissions, than in the 
case where the transactions are brought to an exact balance by Journal 
entries. It will also be found in many cases that a bookkeeper, who would 
be unable to understand and operate controlling accounts if it were neces- 
sary to pick up the entries in such a way, can carry out the procedure 
successfully if he is required to follow our pro forma entries, such as have 
been outlined. 

In addition, the summary Journal entry is theoretically sound, because 
it restores to the Journal its function of a complete, although summary, 
record of the transactions. Practically, it is satisfactory to bring into the 
books a summary of the month’s business that can be understood and 
grasped as a whole. It is not only useful to the accounting staff, but con- 
veys a great deal of information to a proprietor first hand from the books, 
even without a technical knowledge on his part. It is found in many 
cases that this method of securing information appeals more to a pro- 
prietor than the inspection of prepared statements. 


The Cash Book. 


A thorough understanding of the Cash Book ruling that is necessary 
in the use of Controlling accounts, is essential at this juncture. 

The ruling on the debit page of the Cash Book, beginning with the 
money column to the left and proceeding to the right, may be Net Cash, 
Discount, Customers, Creditors, Cash Sales, and General Ledger, thus: 


Dr. CASH. 


— 


Date Item ) Pee oe Net Dis- | Custom-| Credit- | Cash | General 
Cash count ers ors Sales | Ledger 


The initial cash balance and all cash receipts are entered in the Net 
Cash column. 

In case of the settlement of an account by a customer by payment of 
cash under discount, the amount of cash is entered in the Net Cash col- 
umn, the amount of discount in the Discount column, and the sum of the 


117 


two, which is the amount to be credited to the customer, is entered in the 
Customers’ column. 

The Creditors’ column is provided to take care of the possible receipt 
of cash from a creditor, which might come about by the return of goods, 
or otherwise, and while the ruling should be provided, its_use is compar- 
atively infrequent. For the sake of simplicity no transactions of this 
kind were included in the illustrative Controlling Account before given. 
The procedure is to carry the amount of cash into the Net Cash column 
and extend the amount to the Creditors’ column. 

In the case of cash sales the amount is carried into the Net Cash 
column and extended to the Cash Sales column. 

In the case of a cash receipt affecting a General Ledger account, as, 
for instance, the sale of Real Estate, the amount would be carried into 
the Net Cash column and extended to the General Ledger column. 

The opening cash balance being carried to the General Ledger column, 
a proof of the accuracy of the distribution in the columns is effected 
by determining if the summation of the totals of the Net Cash and 
Discount columns equals the summation of the totals of the other 
columns. 

Bearing in mind the various columns that have been indicated, the 
summary Journal entry covering the transactions, would be as follows: 


SUNDRIES To SUNDRIES 
For summary of cash receipts, for month of........ as 
under: 
CASH. For receipts (other than opening balance)....... 
Poben AUN bdsesa: Sac ites “ule atria). azarae. 6 
CUSTOMERS’ CONTROLLING ACCOUNT........ 
CREDITORS’ CONTROLLING ACCOUNT........ 


GENERAL LEDGER ACCOUNTS (posted in detail). 


The initial cash balance would have to be deducted from the total 
of the Net Cash column and the total of the General Ledger column, in 
order to arrive at the figures for the foregoing entry. 

It will of course be understood that the General Ledger items will 
be posted from time to time, and that in the summary entry at the end 
of the month they are included to complete the entry, but are ticked off 
as being already posted. 

On the credit side of the Cash Book the ruling, beginning with the 
money column to the left and proceeding to the right, providing that only 


118 


one column is required for Expense disbursements, may be Net Cash, — 
Discount, Creditors, Customers, Expense, and General Ledger, thus: 


CASH. Cr. 
Date Item Lick se SINEe Dis- | Credit- | Custom- | Ex- | General 
Cash count ors ers pense | Ledger 


a a eee | | | | SS | | ee = | 


The procedure is the inverse of the debit page, and the pro forma 
Journal entry to cover the credit side of the Cash Book, is as follows: 


SUNDRIES To SUNDRIES 
For summary of cash payments for month of...... as 
under: 


GENERAL LEDGER ACCOUNTS (posted in detail). 
CASH.” ‘For payments: >. ss... css «tau. se 
DISCOUNT | i... one cn tle sue mee by et en 


The Customers’ column is to take care of any possible payments of 
cash to customers through the return of merchandise, or otherwise. 

The General Ledger total postings are included merely to complete 
the entry, the postings having been made from the Cash Book. 

It will be noted that the difference between the Net Cash columns 
discloses the cash balance, or the overdraft, at any time, an essential of 
a_satisfactory Cash Book. 

The foregoing entries presuppose the keeping of a Ledger cash account, 
opened by the initial cash balance, and which, under the method shown, 
will disclose the cash receipts and payments by monthly summary entries. 


The Advantages. 


Assuming that there are but three ledgers in the books under con- 
sideration, General Ledger, Customers’ Ledger, and Creditors’ Ledger, it 
is evident that every element necessary to a Trial Balance is embraced 
within the General Ledger. 


119 


If the correct totals have been determined in the books of original 
entry, and correctly transferred to the Journal and posted to the Con- 
trolling accounts, and the balancing of the General Ledger effected there- 
by, the accuracy of the totals shown to be due from customers, and due 
to creditors, by the Controlling accounts, is fairly assured. 

If the total amount due from customers, as shown by the schedule of 
accounts from the Customers’ Ledger, does not agree with the Controlling 
Account balance, there is evidently an error in posting, abstracting bal- 
ances, or in the preparation of the schedule. The same applies to the 
accounts in the Creditors’ Ledger. 

Therefore, the error, or errors, if there be more than one, are local- 
ized, or limited, to a known ledger or ledgers, and no time is lost in going 
over a large part of the work that is accurate. The localization of error 
is the great labor-saving principle of the Controlling Account. 

It will be apparent that the person in charge of the accounts will 
have in his possession a key or check by which he may require subordi- 
nates to achieve a certain result. 

Another advantage is that the General Ledger may be written up 
quickly, and statements, in rough, showing profit and loss and financial 
position, prepared, without waiting for the posting and balancing of the 
Customers’ and Creditors’ Ledgers. However, there is a chance of error 
in writing up the Controlling accounts, as for instance, wrong additions, 
or the placing of amounts in the wrong columns in the Cash Book, so that 
the work cannot be considered as proved until the subsidiary ledgers are 
in agreement with the Controlling Accounts. 


Self-Balancing Ledgers. 


If it is desired to make each ledger self-balancing, that is, to embrace 
within itself the elements necessary to a complete balance, it will be neces- 
sary to open in each subsidiary ledger a General Ledger Controlling Ac- 
count, which will be a summary account in inverse form to the Control- 
ling Account of the subsidiary ledger in the General Ledger. 

Thus, in the Customers’ Ledger, the General Ledger Controlling Ac- 
count would be credited with the total sales, debited with cash payments 
and discounts, and debited with returned sales and bills receivable. 

Likewise, in the Creditors’ Ledger a General Ledger Controlling Ac- 
count would be established, charging it with the total purchases, and 
crediting it with cash payments, discounts, bills payable, and returned 
purchases. 

This arrangement, carried out in the subsidiary ledgers, will provide 
the elements in each that are essential to a trial balance. This is some- 


120 


times desirable as a source of satisfaction to the ledger clerk, although, 
inasmuch as the chief bookkeeper has in the General Ledger a controlling 
account that supplies all the facts that would be contained in the con- 
trolling account in the subsidiary ledger, all of the advantages are secured, 
even if each subsidiary ledger is not made self-balancing. 

In the case of the division of the General Ledger into Private Ledger 
and General Office Ledger, it is sometimes desirable to have in the Gen- 
eral Ledger a Private Ledger Controlling Account, the mere balance of 
which will mean but little to the clerk in charge, but which will enable 
him to test the accuracy of the ledger by taking a trial balance, as will 
be explained later. 


Private Ledger. 


The Private Ledger, as has been pointed out, is a ledger in which. 
are kept the accounts necessary to determine the financial position and 
earning capacity of an enterprise, and it is usually kept by someone in 
the confidence of the management in order that such information may 
not become the common knowledge of the office employees. A Private 
Journal is preferably used with the Private Ledger and is kept by the 
same person. 

The accounts will include, as the book is often kept, the assets of 
the business, with the exception of accounts receivable and cash, and the 
liabilities of the business, with the exception of accounts payable. The 
items that are excepted are taken into the Private Ledger by means of 
a controlling account that measures the difference between such assets. 
and liabilities. This difference is usually a debit, measuring the excess 
in amount of the cash and accounts receivable over the accounts payable. 
By means of this controlling account, in conjunction with the other assets 
and liabilities, the correct capital of the undertaking is shown in the Pri- 
vate Ledger. 

The Private Ledger is opened by an entry in the Private Journal 
debiting in specific asset accounts the items of assets that would appear in 
the Private Ledger, such as Real Estate, Machinery, etc., and crediting in 
specific liability accounts the liabilities other than accounts Payable, for 
example, Mortgage Bonds Payable. In addition, the net debit or credit 
excess by reason of the difference between cash and accounts receivable 
on the one hand, and accounts payable, on the other, is carried into the 
entry. Thus, the entry necessary to open the Private Ledger might be 
as follows: 


121 


SUNDRIES To SUNDRIES 
For assets and liabilities of Doe & Roe as at January 
1, 1902, as under: 
Bote ls Ey Le rd. toe ee een een et FOE | 
Be RCEL leven te, 2, et tener eer a eee 


GENERAL LEDGER CONTROLLING ACCOUNT. 
MORTGAGE BONDS PAYABLE.............. 
ret ACCOUIN yo ae ies tro ela oo 

The General Ledger Controlling Account balance in the 

above is the difference between the assets and liabili- 
ties carried into the General Ledger, as under: 


Accounts Receivable: :)o01 2. c.mimath eneigous $ 
ETE SINEAD TE SO TR CRE ORE 5) UEP UN et aD 

THEA OE ee ee ee ee an eee $ 
Less: 


In the General office books, an entry is passed in the Journal debiting 
the Accounts Receivable and Cash, and Crediting Accounts Payable and 
Private Ledger Controlling Account, thus: 


SUNDRIES To SUNDRIES 
For assets and liabilities carried in Private Ledger 
by Controlling Account, as under: 
ACCOUNTS RECEIVABLE (in detail).............. 


ee NCL ye AN AD Ee oe a Mee ts a os woe vig oto) 
PRIVATE LEDGER CONTROLLING ACCOUNT 


The General Ledger being opened on the above basis, the balance of 
the Private Ledger Controlling Account in the General Ledger will equal 
the balance of the General Ledger Controlling Account in the Private 
Ledger, and the two ledgers are thus articulated by the controlling ac- 
count expedient. It will be observed that there is a ledger account main- 
tained for each asset and liability, although each ledger contains but a 
part of such accounts. 


122 


If the business is large enough to justify it, a subsidiary ledger is 
opened for Accounts Receivable, and a subsidiary ledger for Accounts 
Payable, a controlling account being opened for each in the General Ledger 
along the lines that have heretofore been set forth. 

It will aid in a clear understanding of the plan of the ledgers if the 
Private Ledger is considered as the real ledger, embracing in detail or 
summary form all of the accounts and controlling the General Ledger, 
which, in turn, controls subsidiary ledgers containing the accounts of 
customers and creditors. 

In case of the installation of this method in a going business, the 
General Ledger previously used should be closed completely, and entirely 
new ledgers opened, in order that there will be no trace of the accounts 
that are to be treated as private. 


Transactions During Accounting Period. 


Transactions may take place during the accounting period, after the 
installation of the Private Ledger, that affect accounts in both the General 
Ledger and the Private Ledger. For example, real estate may be sold for 
cash, the treatment of which illustrates the procedure. This would be 
recorded in the general books by an entry debiting Cash, and crediting 
Private Ledger Controlling Account, and in the private books by an entry 
debiting General Ledger Controlling Account and crediting Real Estate. 
Entries of this nature would be comparatively rare, and could be taken 
into the private books by entries in the Private Journal at the end of 
each month. 

As purchases are made, they are recorded in the usual way in the 
general office books, an account being opened in the General Ledger and 
charged with their amount. Sales are also handled in the General Ledger, 
an account being opened and credited with the amount thereof. In case 
a Merchandise account is used the charges for purchases and credits for 
sales will be made to it instead of to the separate Purchase and Sales 
accounts. 

Nominal accounts are raised in the General Ledger to record the 
various classifications of expense, such as Wages, Salaries, Rent and 
Expense, and to record any item of profit that may be secured, and, under 
ordinary circumstances, the Private Ledger would not be affected thereby 
during the accounting period. 


Entries at Time of Closing Books. 


The first procedure at the time of closing the books is to have a trial 
balance of the General Ledger taken. The nominal accounts appearing 


123 


thereon are closed into the Private Ledger Controlling Account, prefer- 
ably by a Journal entry. Thus, the amounts standing to the debit of such 
accounts as Purchases, Wages, Salaries, Rent and Expense, are charged 
to the Private Ledger Controlling Account, and the accounts are credited 
to balance. The accounts with credit balances measuring nominal ele- 
ments, including sales, are closed by debit entries and their amount cred- 
ited to the Private Ledger Controlling Account. This will bring the General 
Ledger to its original position, as far as classes of accounts are concerned, 
disclosing Accounts Receivable and Cash, on the one hand, and Accounts 
Payable on the other, the Private Ledger Controlling Account establish- 
ing the equilibrium. A Trial Balance should then be taken to prove the 
-accuracy of the work. 

The Trial Balance taken before the transfer of the nominal balances, 
and the one taken afterward, are supplied to the person in charge of the 
private books. The inventory of stock is ascertained, preferably by some 
one other than the clerk in charge of the General Ledger, if it is desirable 
to withhold from him the result as to profit and loss. Any other informa- 
‘ tion necessary to the determination of profit and loss is obtained, and 
the closing of the books is carried out in the private books. 

At this juncture it should be recalled that the Private Ledger contains 
all of the assets and liabilities in specific accounts, with the exception of 
the assets and liabilities carried in the General Ledger. It contains the net 
effect of the latter in a controlling account that, at the beginning of the 
accounting period, represented the true position. So far as entries con- 
cerning accounts carried in both ledgers are concerned, their effect has been 
carried in from month to month. But the effect of the nominal account 
in increasing and decreasing assets and liabilities in the General Ledger will 
not have been carried into the Private Ledger. Thus, if Sales amounted 
to $100,000, and Purchases and Expenses to $95,000, the effect upon the 
net asset value recorded in the General Ledger would be an increase of 
$5,000. It is, therefore, necessary at the end of the accounting period 
as a preliminary to the closing entries, to bring the nominal accounts into 
the Private Ledger, setting them up in ordinary ledger accounts, and to 
carry their difference, or net effect, to the General Ledger Controlling 
Account. This is accomplished, preferably, by an entry in the Private 
Journal, thus: 


124 


SUNDRIES To SUNDRIES 
For the raising of nominal accounts and adjustment 
of General Ledger Controlling Account, as under: 
PURCHASES: J .:5..dawooek. sectional he a 


EXPENSEsi0.s 52638). a 2eb ee ene, ee 
GENERAL LEDGER CONTROLLING ACCOUNT. 


From this point, the Private Ledger having been brought to an agree- 
ment with the General Ledger, and containing all of the nominal elements 
for the accounting period, the procedure is the same as in closing a set of 
books under ordinary conditions. The entries are passed through the 
Private Journal. A Trading Account is raised, to which the opening 
inventory, and the purchases, are charged, the latter being credited to 
balance. The sales and closing inventory are credited to the Trading 
Account, the Sales Account being debited to balance it, and the new inven- 
tory being set up by a charge to Inventory. The balance, measuring ordi- 
narily a gross profit, is transferred to the Profit & Loss Account, and the 
Trading Account is closed. The nominal elements appearing in the nominal 
account are then closed into the Profit & Loss Account, the amount of 
the expenses being charged and the amount of the profits being credited 
thereto, the nominal accounts being closed. The balance of the Profit & 
Loss Account, measuring the net profit or net loss for the period, is car- 
ried to the withdrawal accounts, if any, and the balances of the latter are 
carried to Capital, and measure the net increment or decrement of capital. 

The Private Ledger, at this stage, will, as in the beginning, disclose 
all of the assets and liabilities, and the capital, of the enterprise, although 
the net asset value recorded in the General Ledger will appear only by the 
balance of the General Ledger Controlling Account. 

If the foregoing method is carried out, the object of the Private Ledger 
will be fulfilled. Even the bookkeeper in charge of the General Ledger, 
if the opening and closing inventories are withheld from him, cannot 
determine the outcome as to profit and loss. The bookkeeper in charge of 
the General Ledger, however, is usually more or less in the confidence of 
the management and, in fact, often has charge of both the General Ledger 
and the Private Ledger. Where this is true, the object of keeping the 


125 


Private Ledger is that the clerks other than the bookkeeper in charge of 
the General Ledger, who may have occasion or opportunity to consult the 
General Ledger, may not ascertain the confidential matters. 

There are many variations of the method given. In case the confi- 
dential clerk has charge of both the General Ledger and the Private 
Ledger, the desired results may be obtained by keeping a Private Ledger 
with only such accounts as would readily disclose confidential information, 
such as the Capital, Profit & Loss and Withdrawal accounts. From the 
principles and full procedure given any of the other methods may be 
worked out, and, in fact, are but variations thereof, more or less com- 
plete, as the particular case requires. 


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_ THEORY AND PRACTICE OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


_ By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE X. 


ARITHMETICAL EXPEDIENTS., 


PVE AGH LIU WH OATES Voc l es eg Goo cree es WON yh tr See Ua des 126 
PV BRACING ACCOUNTS 6.0 ho Se ea ei ow ee 130 
DETERMINATION OF TIME IN CALCULATING INTEREST ... 132 
rr Ay, Metro oe a ae 134 


COPYRIGHT, 1914, BY 
HoMER St. CLAIR PACE. 


PACE & PACE 


wy PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


Ba 90 CHURCH STREET, - NEW YORK CITY 





THEORY AND PRACTICE OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


PaO MVMIGRE SI. CEATR, PAGE ;..€. PA.’ (N.-Y¥.) 
LECTURE X. 
ARITHMETICAL EXPEDIENTS. 


Average Due Date. 


It is often necessary, in the case of amounts falling due at various 
dates, to determine a date at which settlement can be made of the total, 
without prejudice, in the matter of the use of money, to the respective 
parties. Such a date is known as the average due date, or equated 
time of payment. 

The common interest procedure, which does not give in itself the 
equated time of payment, is the calculation of interest upon each item 
at the agreed rate to some common date. 

Thus, A advances to B the sum of $4,000, on dates and in amounts 
as under: 





1902 
Tee ou Gn sem tera ey, GEM Tn. $1,000 
‘Lota SER ae 4 Cie) OF TC fe 7 ye fe 2,000 
Bee eh aia es asides, on xe en dk a gb wid si Be es caste) 1,000 
TEM Me OY eae AN Ai RI Rs $4,000 








It might be desirable on the succeeding 15th day of July to determine 
the amount then due A, allowing 6 per cent. interest upon his advances. 


The calculation may be made as follows: 
Amount on which 





Time in days to calculate  in- 

Date Amount to July 15th terest for one day 
1902 

June 1 $1,000 x 44 _ $44,000 

June 15 2,000 x 30 == 60,000 

June 30 1,000 x 15 =a 15,000 

$4,000 $119,000 








Copyright, 1914, by Homer St. Clair Pace. 


127 


The total, 119,000, represents an amount of dollars upon which interest 
should be figured for one day. Pointing off two places gives the interest 
at the agreed rate, 6 per cent., for 60 days, $1,190. Dividing 1,190 by 60 
(cutting off the cipher in each case and dividing by 6) gives a result of 
$19.83. Adding the $19.83 to the $4,000 advanced, gives $4,019.83, the 
total due A on July 15th. 

It might, however, be desirable for B to give A a note for the sum 
of the advances, $4,000, with interest at the agreed rate, dated upon the 
average due date, in order to give the correct interest return to A. 

For the purpose of determining such a date, reference should be made 
to the table before given, in which the proposition is reduced to the calcu- 
lation of interest for one day upon $119,000. This proposition may be 
stated inversely; viz., that one day’s interest upon $119,000 is the same 
as interest upon $1.00 for 119,000 days. In order to give effect to the 
varying amounts and the time that each has to run, interest may be cal- 
culated upon $1.00 for 119,000 days. If $1.00 would run 119,000 days, 
$4,000 would run for as many days as 4,000 is contained in 119,000. The 
quotient is 293, or, say, 30, the number of days for which the interest 
runs on the whole amount of $4,000 previous to July 15th, or from June 
15th, the average due date. 

To prove the average due date, interest upon $4,000 for 30 days at 
6 per cent. is $20.00, or, to be exact, using 293 days, $19.83, the same 
as was determined by the calculations upon the separate amounts. 

Aside from the calculations and their proof that have been given, 
the equated date of payment is obviously June 15th, inasmuch as the 
first and the last amounts are the same, and are equally distant in time © 
from the intervening amount. Charging interest upon the first advance, 
$1,000, for the month, would obviously produce the same result as charg- 
ing interest upon the sum of the first and last advances, $2,000, for the 
half month beginning with June 15th. 

In practice, it is necessary, owing to the more complicated conditions 
likely to exist, to determine, as shown, the required date by an arith- 
metical process that will give due weight to the various amounts that 
enter into the total, and to the time that each amount has to run. It is 
always necessary to select arbitrarily a date to which, or from which, 
the time in days is calculated in respect to each item. The variations 
will give the weight as to the time that each has to run; and the weight 
as to amounts is obtained by multiplying the number of days in each 
case by the amount of each item. 

It is found convenient to select as a basic date one of the dates in the 
series, to save a calculation, preferably the first or the last of the dates 


128 


given. If the proposition is worked on this basis, and if June 1st is selected, 
the results are as follows: 








Date Amount Days from June lst Products 

1902 
June 1 $1,000 ~ 0 = | 0 
June 15 2,000 x 14 _ 28,000 
June 30 1,000 x 29 = 29,000 
$4,000 57,000 





Dividing 57,000 by 4,000 gives a quotient of approximately 14. In 
this case, if a prior date is selected, the number must be added to the 
basic date, instead of subtracted. If 14 days are added to June (st, 
the same result as before, June 15th, is obtained. 

Another and more complicated example will be given, the dates and 
amounts being as under: 





1902 
Stay SAS oc PEL RORY EAS APO ORO LTS Pe eat $650 
TLS US Ie epee OLY ere a ea 500 
OTe RU vcd eee eer nie Mk ac. Aa Ayman Lee Oe ge 250 
IO nee rine eRe ig eae as oes ee 300 
aapesl aC 0 NEC 8s OL ae a de $1,700 








Required, average due date. 
The last date is used as the basic date, to show the procedure when 
the last date is selected; and the days and products are: 


Date 


Amount 











Days to November Ist Products 

1902 
Sept. 9 $650 x 53 _ 34,450 
Cy. 0 500 x 26 —— 13,000 
Oct 9 250 x 23 =e 5,750 
Nov. 1 300 x 0 = 0 
$1,700 53,200 


If 53,200 is divided by 1,700, the result is approximately 31, and 31 
days previous to November ist, the basic date, would be October 1st, 
the average due date. 

This result may be proved by calculating interest to any desired 
date, upon the various items for the time each item has to run, and upon 
the entire amount from the average due date. For the proof, interest 
will be calculated at 6 per cent., to November 1st, upon each item, thus: 


129 








$650 53 days @ 6% =a $5.74 
500 26 days @ 6% oa: 2 sit 
250 23 days @ 6% — .96 
300 0 days @ 6% — 0 
$1,700 $8.87 














$1,700 311 days (adding 4 necessary to give absolute check) $8 .87 














If one of the dates other than the first or the last date is chosen, the 
difference. between the products previous to the date, and subsequent to 
the date chosen, must be used as the dividend, and the days calculated 
toward the greater weight of products. 

Thus, in the calculation, if the third date, October 9th, had been 
chosen as the basic date, the results would have been as under: 











$650 ~*~ 30 ane 19,500 
500 ek 3 een 1,500 
250 +4 Vi ee 

DTotal ores. dscns re ee oe 21,000 
300 x 23 — 6,900 
$1,700 | 14,100 














If the difference of the products is divided—14,100 by 1,700—the 
result is approximately 8. As the greater weight of products is previous to 
that date, it is necessary to count backward eight days from October 9th 
to find the average due date, which, as before, is found to be October Ist. 

Illustrations have now been given in which a first, a last, and an 
intervening date, and a date entirely outside of the dates of the money 
items, have been used as a basis; and the average due date obtained has 
been proved in each case by interest calculations. 

There are other methods based upon interest calculations, of calcu- 
lating the equated time of payment, but the method given is sufficiently 
brief, and is easily understood and applied. 

A method that is found convenient when the account extends over 
a long period, and when months intervene between the items, is based 
upon calculations of interest at the rate of one per cent. per month. This 
rate is selected because of the convenience in calculation—any other 
rate would give the same mathematical result. The interest on each 
amount is calculated from a convenient date, say the first of the month 
in which the first amount appears, to the date of the respective item, 


130 


at the rate of one per cent. per month. The total of such interest is then 
found. The items of principal are then totaled, and one per cent., or a 
month’s interest, is determined by pointing off two places. Dividing this 
amount by 30 gives the interest on the total amount for one day. If the 
amount arrived at from interest calculations be divided by the amount 
that represents the interest on the total of principal for one day, the quo- 
tient will be a number that will indicate the number of days between the 
basic date and the due date. Applying this principle to the foregoing 
example, the following result is obtained: 


Time from 
Date Amount September 1 Interest 
PME OUR. ic ok cl $650 8 days $1.73 
oS See ate 500 1 month 5 days 3.83 
rey eit ken hes. 250 1 month 8 days Sed 
Sh aaa cane 300 2 months 1 day 6.10 
$1,700 $16.83 


Placing the point in the 1,700 gives a result of $17.00, interest for 
one month at one per cent. on the total amount. Dividing this amount 
by 30, the number of days in the month, gives approximately .57, the 
amount of interest on the total amount of principal for one day. Divid- 
ing the interest as above, $16.83, by the foregoing quotient, .57, gives a 
quotient of 30. Calculating 30 from the basic date selected, September 1, 
gives the average due date as October 1, the same as was obtained by 


the other method. 
Averaging Accounts. 


In a previous Lecture, an Account Current was given which is re- 
produced here in running form, as under: 


HENRY SMITH 
IN ACCOUNT WITH 





July, 1902. CARLING & CO., Factors. 

Dr. 
Time Interest 
Date Item Amount (days) 6% 
1902 

en OA dg oy oy Sue sas $2,000.00 8 $9.67 
eM LO 1,000.00 1 a 
waived) §=~LO interest, 0%, contra......... 0 7, 14.41 


Maro re palarice Gown ee 1,814.41 i 0 





$4,814.41 ret $17.25 








131 
Cr. 











Time Interest 
Date Item Amount (days) 6% 
1902 
jalyrd By Aocount Sales. sat). Meee $1,000.00 30 $5 .00 
aL SOR Vita Coount pales | oa) peeas hos 2,500.00 fh S.L5 
ive ID YeACCOUN Dales tc lol Perouse 500.00 18 TS 
Juby716" (By Actount Sales... cans see ae 800.00 i 2.00 
July 31 By Interest, net credit contra..... 14.41 ae. 0 
$4,814.41 Ps $17.25 
1902 


Apt sRy Balance rye vk. ci eens $1,814.41 


Assuming that the amounts to the credit of Henry Smith were pay- 
able at the dates named, and that the debits were proper offsets at their 
respective date, the date is required at which it would be equitable for 
Carling & Co. to date their note, bearing interest, in settlement of the 
balance of the principal of the account, $1,800, instead of reaching a set- 
tlement on the basis of the Account Current. 

It is necessary to determine the products of the sides from or to a 
common date, the same as if the average due date of each side were being 
determined. If we proceed in this way to the last date named, July 30, 
the results are: 











Credits: 
$1,000 x 29 — 29,000 
2,500 x 20 = 50,000 
500 x 17 ae 8,500 
800 x 14 = 11,200 98,700 
Debits: 
$2,000 x 7 —— 14,000 
1,000 x 0 = 0 14,000 
Excess of creqdits...; Seas eee) ee) eee eee 84,700 








Dividing the excess of products, 84,700 by the balance of the account, 
1,800, gives, as a result, 47. That is, analyzing the process, Henry Smith 
is entitled to the use of $1.00 for 98,700 days; and, as an offset, Carling 
& Co. is entitled to the use of $1.00 for 14,000 days, the excess in favor of 
Henry Smith being the use of $1.00 for 84,700 days. Inasmuch as $1,800 
is due Henry Smith on account, he will be entitled to the use of $1,800 


toe 


for as many days as 1,800 is contained in 84,700, or 47. The time must 
be calculated backward, so that it may be determined that 47 days pre- 
vious to July 30 is June 13 the date from which interest must be com- 
puted on $1,800. 

In the Account Current, interest is calculated to July 31; so, in com- 
puting interest as a check upon the accuracy of the due date, one day 
must be added to the 47 days, making 48 days. The calculation of inter- 
est at 6 per cent. upon $1,800 from June 13th to July 31st, 48 days, is 
made by pointing off two places to obtain interest for 60 days, $18, and 
by taking away one-fifth, for the 12 days by which 60 exceeds the actual 
48 days, $3.60, leaving $14.40. This result is within one cent of the amount 
achieved in the Account Current by figuring the interest on the debit 
and credit items, and by deducting the interest upon debit items from the 
interest upon credit items. 

Other dates may be selected as a basis, but the method given, has, 
perhaps, the fewest complications. 

An understanding of the reason for the processes is much more essen- 
tial than memorizing a formula. The latter is likely to be forgotten, but 
a knowledge of the principle will remain and may be of use in a situation 
that the process does not cover. 


Determination of Time in Calculating Interest. 


A detailed consideration of the methods of calculating interest is 
not within the scope of this Lecture. It is thought desirable, however, 
to consider several phases of the subject, particularly in relation to the > 
computation of time. 

The ordinary commercial method of calculating time is to assume 
that there are 360 days in a year, that may be divided into 12 parts of 
30 days each, corresponding, although not exactly, to the 12 calendar 
months of the year. The exact days are counted, and, for example, may 
be found to be 75. If 75 is divided by 30, a result of 24 is obtained. Thus 
the interest must be calculated for two months and 15 days. For this 
time 24 twelfths, or 5-24, of the yearly rate must be taken. 

This method answers well enough for short-time periods, although 
carried to its logical conclusion, by counting all the days for a year 365, 
and by dividing by 30, a result of 124 is obtained, so that in a year the 
inaccuracy amounts to 4 of a month, or five days. That is, 365-360 of 
the rate is charged, amounting to an excess of 5-360, or 1-72. 

It has been held that such excess, growing out of the method of cal- 
culating interest, when it brings the actual interest collected above the 
legal rate, does not constitute usury. 


1535 


In case an amount is payable in a month, the due date falls on the 
same date of the succeeding month, irrespective of the number of days 
elapsed. A note dated on January 31, payable in a month, would fall due 
on the last day of February. The calendar months are recognized in this 
way. In fact, it is not at all uncommon for interest to be calculated upon 
the basis of calendar months, each to take 1-12 of the rate; and the re- 
maining days are taken as their fractional part of a 360-day year. Thus, 
interest is to be calculated from June 10th to September 15th. The time 
from June 10th to September 10th is taken as three months, and for the 
time from September 10th to the 15th, there must be added 5 days, mak- 
ing the total time 3 months and 5 days. Had the first method been fol- 
lowed, the result would have been: 


Days in June, . oS 225° eae eee 20 
Days an J tly. cio yc sua a clea eke ae ee ee 31 
Days in August oss. hes eee re eee 31 
Days in September...i.... / 5. See 15 

Total); } ivi. ails abel 5 eee 97 


Dividing the 97 by 30 would give 3 months, 7 days, a difference of 
2 days. 

The two methods may thus work different results, depending upon 
the variations in the number of days in the calendar months. For long 
periods of time, approaching a full year, the last method gives more nearly 
the correct result. The discrepancies in each method, from the commer- 
cial viewpoint, are compensated by the ease of calculation obtained in 
the 360-day method. 

The time in obtaining exact interest is determined by taking the 
actual number of days, and by calculating the same proportion of the rate 
as the number of days bears to the 365 days of the year. Thus, in the 
case of interest running for 75 days, 75-365 of the rate, instead of 75-360, 
would be used. Thus the error of 1-72, as pointed out in the 360-day 
method could be avoided. This method, used by the Government, is 
known as the 365-day method, and is rarely used in business. 

In either method, in determining the number of days between two 
dates, one is included and one is excluded. In New York, the date 
from which the time runs is excluded, and gives the effect of the exclu- 
sion of one day. Thus, in the case of a loan running from June 15th 
and payable July 10th, the count could be made conveniently by deduct- 
ing 15 from 30, the number of days in June, which leaves 15. Deducting, 
in a month, one number from another, includes one of the numbers and 
excludes the other. To the 15 must be added the total number in July, 


134 


10, because the exclusion has been made in June. Thus 25 is given as 
the number of days for which interest should be calculated. 

Custom usually determines the method. It is incumbent upon the 
accountant to know the various methods of computing time, and the 
effect of each, although it is not often his province to insist upon a change 
in method that will produce a more nearly correct result when such a 
change is opposed to accepted commercial usage. 


Sixty-Day Method. 


There are many methods of calculating interest in use. One of the 
best for ordinary purposes is the 60-day method, which has been used in 
illustrative calculations. It proceeds upon the basis of the 360-day year 
and the six per cent. rate; that is, one-sixth of the rate, or 1 per cent., is 
applicable to one-sixth of the time, 60 days, or two months. Inasmuch 
as 1 per cent. may be found by pointing off two places in the principal 
sum, the interest on the amount in question for 60 days at 6 per cent. 
is obtained by placing a point. If the days are greater or less, an amount 
in proportion is respectively added or subtracted. The sum is then re- 
duced to the actual rate should it vary from 6 per cent.; that is, if the 
rate is 5 per cent., one-sixth of the amount is deducted. 









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THEORY AND PRACTICE OF AUDITING. 
- “ By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE I, 


PRINCIPLES AND DEFINITIONS. 


WING BNE BATES CN ti oy oa iy, LCi eae hve trie Se ees dea ee 
ERRORS IN THE ACCOUNTING RECORD.. eae tore ra a Mulia hac 2 
Tus NECESSITY FOR VERIFICATION OF THE AccoUNTING RECORD.... 3 
“URUDITING. Wo. 2. ey OR PUL RS AIL ipo ane Wee te RTs UA | 4 
Pee rors OF VERINIGATION Vi. ty 2 u St set ae Wee 5 
ee eon REPORT OC eM oe tun pe eh vee 7 
PAINCTIONG UT ERMO IK Mae a he aya a eke 9 

P VERIFICATION e000): Be ee a een ey el weape WAU 10 


COPYRIGHT, 1913, BY 
Homer St. CiatrR Pace, 


ee 4 
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THEORY AND PRACTICE OF AUDITING. 
By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE I. 

PRINCIPLES AND DEFINITIONS. 


In General. 


Accounting, in a broad sense, is the recording of facts as to the acqui- 
sition and disposition of values, and as to the incurrence and discharge 
of liability for values. In respect to the particular undertaking, the 
excess of the values possessed over values owed, at any moment of time, 
is the investment or accounting capital of the enterprise, and the financial 
position is displayed by setting forth the values possessed, or assets, in 
opposition to the values owed, or liabilities, in conjunction with the ac- 
counting capital. It is evident that the facts displayed in opposition will 
produce an equilibrium, which provides the necessary prerequisite to the 
future record of increases and decreases of value by the bookkeeping 
device known as double entry. It is essential to a satisfactory accounting 
record that this initial financial position be established. 

' The subsequent record must disclose, in chronological form, the 
increase and decrease of assets and liabilities, classified in such a way 
as will be most convenient and informative in respect to the specific 
enterprise. 

In order to determine the increase or decrease of the accounting 
capital invested, it is necessary to determine, after the lapse of any desired 
period of time, the value of assets and amount of hability, the excess of 
the former being the capital. 

While the comparison of a known opening financial position with a 
known subsequent financial position will disclose the net difference in 
the accounting capital of the undertaking, it does not, in any way, dis- 
close the reasons for the net change, either in respect to particular values 


or in respect to the undertaking as a whole. 
Copyright, 1913, by Homer St. Clair Pace 


2 


The chronological record, connecting the original position with a 
subsequent position, is necessary in order that the business transactions 
may be recorded in such a way as to show the reasons for the change 
in investment. Information is thus obtained for the purpose of augment- 
ing results that have been beneficial, and for decreasing, or eliminating, 
results that have been detrimental. 

The accounting record is effected, preferably, through double entry 
bookkeeping, which constitutes the means by which the accounting results 
are obtained. Double Entry bookkeeping is accepted as the standard 
means of expressing accounting results, because it meets the essential 
requirements of an adequate accounting record while the other devices do 
not. However, unscientific devices are often employed, and the double 
entry method may be so improperly handled as to achieve but a small 
part of the desired results. 

The recorded initial financial position, the chronological record there- 
after, whether properly kept or not, and the subsequent financial position, 
cover the range of the accounting period. From the record and facts 
must be gained the knowledge of the assets and liabilities, and the profits 
and losses, of the particular undertaking, for which the accounting record 
is inaugurated and maintained. 


Errors in the Accounting Record. 


In the making of an accounting record, there is always the possibility 
of errors. The errors may arise unintentionally through an imperfect 
knowledge of accounting and bookkeeping: methods, and may consist of 
either of the following: 

1. Errors of principle, affecting the statement of asset and liability 
elements or financial position, and the profit and loss or revenue trans- 
actions that lead to such statement of financial position. Thus, if the 
replacement of a capital asset, that is, one acquired for the permanent 
use of the enterprise, when worn out, is made out of funds contributed 
as capital, and not out of funds secured through the use of capital assets, 
an error of principle is committed, misstating the revenue-producing or 
profit capacity of the undertaking. 

The errors may be of omission, not appearing in the record, as well 
as those of commission. Thus, if an expense and resulting liability are 
omitted, the profit increment will be overstated. 

2. Errors of technique, affecting the bookkeeping accuracy, such as 
a wrong posting or error in addition. Errors of this class may not affect 
the statement of assets and liabilities, and profit and loss, as in the case 
of a nominal element being carried by mistake to a rent account instead 


3 


of to a salary account. However, should a nominal element be carried 
to an asset account, through an error in posting, it would be a technical 
bookkeeping error, although achieving, if undiscovered, the same result 
as an error in principle. 

Errors of technique, too, may be of omission, as where an inventory 
item and the liability therefor, are not raised in the books, on the theory 
that, inasmuch as the entry does not change the net results, it need not 
be recorded. 

As distinguished from unintentional errors, there may be intentional 
errors, made: 

1. For the purpose of misstating the financial position, or revenue- 
producing capacity, of the undertaking; 

2. For the purpose of covering direct peculation or fraud on the 
part of the one entrusted with making the accounting record. 

In the first instance, the proprietor may cause the error to be made 
for the purpose of securing loans or credit, or to secure unduly favorable 
terms upon sale. The second class covers fraud and embezzlements, 
ordinarily carried out by the purloining of cash and the falsification of 
records to cover the theft. 


The Necessity for Verification of the Accounting Record. 


The simplest state of affairs that can be imagined in respect to the 
keeping of an accounting record, is the case of the person who personally 
knows every detail of the business involved, and who personally makes 
the accounting record. In such a case, the business would be so small that 
the owner could check the accounting record with his personal knowledge 
to such an extent that the errors would be trivial, except possible inten- 
tional errors on the part of the owner. 

The next step in the development of a complex organization is a 
small business in which the proprietor has so few assistants, and devotes 
so much of his personal attention to the transactions, that he knows from 
time to time, the amount of property he owns, and the financial obliga- 
tions to which he is subject, and what the approximate outcome should 
be in relation to the profit and loss of the undertaking. 

In a larger business, and increasing with the magnitude of transac- 
tions involved, the proprietor is dependent to a greater extent upon his 
employees, and especially upon the employees who maintain the account- 
ing record, to determine from time to time his financial position and the 
results of the business transactions. 

The greater the size of the business, the greater his dependence must 
be, and the more difficult it is to devise and verify an accounting system 


4 


by means of which those entrusted with large operations can keep in touch 
with the multitude of details which, in the aggregate, produce, or fail to 
produce, the results for which the undertaking is operated. 

The office manager, or bookkeeper, who maintains the accounting 
record, no matter what the size of the undertaking may be, is obviously 
not competent to certify to his employer as to the absence of errors of 
principle and technique, for it may be assumed that the bookkeeper, 
granting his honesty, will keep the accounting records as well as his 
knowledge and experience permit. Even to a greater extent, the book- 
keeper or office manager is not competent to testify to the absence of 
fraud, for, being an interested party, his evidence might be influenced 
by self-interest. 

However well the business man may be satisfied as to the adequacy 
of his accounting record, and the integrity and competency of the person 
in charge thereof, when, for the purpose of obtaining credit, he finds it 
necessary to submit financial or earning statements to his bankers or 
others, he labors under the same disadvantages in presenting the facts 
to such persons as does his own bookkeeper in presenting the facts to 
him. That is to say, the banker looks upon him as an interested party, 
apt to be prejudiced, and, other things being equal, places less faith in 
his statement than he would in a statement vouched for by one who is 
not directly interested. 


Auditing. 

Auditing is the verification of accounting records. The necessity 
for auditing arises from the lability of error, either intentional or unin- 
tentional, and either of commission or omission, and the business necessity 
of an independent determination of an accurate accounting record, both 
as to possession of values and liability for values, and as to revenue- 
producing capacity. 

Auditing, when properly performed by competent and disinterested 
professional auditors, guards against waste and incompetency of manage- 
ment, and against the evils that come to employer and employee through 
improper supervision of those entrusted with the handling of money. It 
provides the avenue for publicity, and is the means by which the investor 
may be assured of the integrity of his investment, and the competency of 
the men who are entrusted with the management thereof. 

Various though the manifestations of Auditing may be, whether an 
investigation covering special matters, or a detailed examination of the 
record of the financial transactions of an undertaking, it amounts, in the 
end, to the verification of accounting records. 


5 
The Scope of Verification. 


There are different kinds of audits, depending upon the nature of 
the verification that is required. The ideal audit is one that covers a 
complete verification of the accounting record from a prior authenticated 
financial position, up to the latest financial position, involving a considera- 
tion of the business with a view not only of verifying the record that has 
been made, but of safeguarding against the omission of transactions that 
are vital to proper statements. 

Thus, if an undertaking was originated on the first day of January, 
1900, and its possession of values and liability for values, absolutely known 
and set forth at that date, an ideal audit would involve a tracing of the 
increases and decreases of assets and liabilities, resulting in a certain 
condition of assets and liabilities as at the end of the period which is being 
audited, say at December 31st, 1900. Such a verification reconciles, by 
the chronological record, the financial position of the undertaking as at 
the beginning and closing of the year 1goo. 

If, at December 31st, 1901, a complete detailed audit for that year 
were desired, the position being verified to December 31st, 1900, it would, 
of course, ordinarily be unnecessary to verify the work prior to such 
authenticated statement of assets and liabilities. Conditions may exist, 
however, that would render necessary a verification prior to the former 
financial statements. 

Therefore, it will be seen that the ideal and full detailed audit con- 
sists in the verification of an accounting record, from some authenticated 
prior position, whether at the beginning of the business, or at the begin- 
ning of some accounting period, down to the subsequent date at which 
it is desired to set forth the accurate financial position of the undertaking. 

The foregoing is known as a detailed audit, although a detailed audit 
may be made, and in fact generally is, without a checking of the complete 
accounting record, as will appear later. 

A completed audit is one in which the verification is made for a cer- 
tain period after the accounting record is complete, and it is made, so far 
as is possible, with the accounting records in possession of the accountant. 
The advantage of a completed audit is that, the entire record having been 
made, there is little chance of alterations in the books, particularly so 
when they are in the custody of the accountant. 

A continuous audit is one in which the work is performed from month 
to month during the accounting period. The advantage of the contin- 
uous audit, as compared with the completed audit, is that errors, either 
of principle or technique, are detected sooner than if the audit were made 


6 


after the end of the accounting period. In addition, the bookkeepers, 
not knowing the exact date when the audit will be made, are under the 
necessity of keeping their work well caught up. The disadvantage of 
the continuous audit is that there is a chance of alterations in the work, 
after it has been audited. Such alterations may cover fraud or affect 
the position at the end of the year, and are difficult to detect without 
re-auditing. 

A balance sheet audit, as distinguished from a detailed audit, is one 
in which the verification is made only to the extent necessary to certify 
that the correct financial position of an undertaking is set forth in its 
Balance Sheet. 

The amount and kind of work necessary for the accountant to per- 
form, in order to certify to the correctness of a Balance Sheet, is a matter 
of some dispute, although unquestionably it should be determined that 
the undertaking possesses assets at least to the amount stated in the 
Balance Sheet, valued in accordance with accepted accounting princi- 
ples, and that the liabilities are not in excess of the amount stated. 

It is sometimes contended that the work consists merely in certify- 
ing that the Balance Sheet is prepared in accordance with the books of 
account. This means nothing more than a transcript of book balances, 
correct or incorrect, as may happen to be the case, and permits of the 
use of the accountant’s name, without extending to him an opportunity 
to perform the work that would render his certificate of value. 

If, in an exceptional case, it should seem to be advisable for an ac- 
countant to make such a certificate, he should state plainly therein that 
he is certifying to nothing further than that the Balance Sheet is in ac- 
cordance with the books. Even this may lead to a misapprehension on 
the part of those who look upon the association of an accountant’s name 
with a statement as, in a measure at least, vouching for its substantial 
accuracy. It is hard for the layman to make the distinction, and it is 
much the better plan for the accountant to avoid such certifications. 

On the other hand, it is not considered necessary to make a detailed 
audit in order to make the certificate, although it is necessary to trace 
profit and loss transactions to a considerable extent, in order to see that 
proper provision has been made for probable losses upon realization of 
accounts receivable, for depreciation, etc. 

It is not intended to give, at this point, more detail than is sufficient 
to fix, in a general way, the scope of the audit. 

An investigation may relate to any particular phase of the account- 
ing record, or it may relate to part or all of the transactions over several 
accounting periods, or over the entire life of the undertaking. It may 


7 


be to determine its earning capacity for the purpose of sale, or the ad- 
mission of a partner; it may be a report upon the property and revenue- 
producing capacity of a corporation, in order to facilitate a sale of its 
bonds; it may be small in scope, but intensive as to detail, or it may 
be wide in scope, with but small reference to detail. 

Whatever the scope of an investigation may be, the accountant will, 
of course, safeguard himself by certifying only to the matters that he 
has actually investigated. 


Forms of Reports. 


The forms in which an accountant may set forth the results of his 
efforts at verification will vary from the mere certification of a Balance 
Sheet to a voluminous analytical report, and, within certain limits, may 
be made to reflect his ability to reduce to clear and concise language and 
statements the facts found to exist. | 

Theoretically, in the case of the certification of a Balance Sheet, it is 
prepared by the regular accounting staff and submitted to the accountant, 
who then verifies the items and certifies that it sets forth the true financial 
position of the concern. Practically, the accountant is more frequently 
called upon to prepare the Balance Sheet, as well as certify to it, and even 
though he is not, a recasting and revision are likely to be necessary. 

If the Balance Sheet, as originally made or recast, is in form satis- 
factory to the accountant and his client, the accountant will give an un= 
qualified certificate. A satisfactory form is as follows: 


THIS CERTIFIES, That the above Balance Sheet of the John Doe 
Company is a true statement of its assets, liabilities and capital as at 
the close of business December 31, rgot. 

RICHARD ROE, 
Certified Public Accountant. 


The form used in certifying to the Balance Sheet of the United States 
Steel Corporation, as published in its annual report, is as follows: 


“We have: audited the above Balance Sheet, and certify that in our 
Opinion it is properly drawn up so as to show the true financial position 
of the United States Steel Corporation and Subsidiary Companies on 
December 31, 1906.” 


If the client insists upon a Balance Sheet that the accountant cannot 
conscientiously certify, or if his investigation has not been full enough 
to justify an unqualified certificate, resort may be had to a qualified cer= 
tificate relieving the accountant from the responsibility of unqualifiedly 


8 


approving the statement. The qualified certificate may give the reasons 
for the qualification, or not, according to circumstances. The following 
is a form of qualified certificate: 


THIS CERTIFIES, That the above Balance Sheet of the John Doe 
Company discloses its true financial condition as at the close of business 
December 31, 1902, subject to the qualifications contained in my report 
of February 3, 1903. RICHARD ROE, 

Certified Public Accountant. 


The certificate may be made to include the revenue accounts of the 
concern, if they have been verified, or each may be certified separately. 

Instead of a certificate, the accountant may make a report, comment- 
ing upon the items of the statements, attaching the latter as exhibits 
to the report proper, and numbering or lettering them for identification. 
Thus, the Balance Sheet may be Exhibit A, the Trading and Profit and 
Loss Account Exhibit B, etc. This, in fact, is the usual form of report, 
and is capable of development sufficient for any report, whether of detailed 
or balance sheet audit, or of special investigation. It is customary, in 
addition to making such a report, to certify to a copy of the Balance Sheet 
so that it may be used for the purposes of the client. 

It is best to adopt, as nearly as may be, a standard form of report, 
using the same stationery, cover and binding, as well as a regular style 
of presentation of subject matter of report and supporting schedules. 
It frequently happens that several reports are made to a client in the 
course of an investigation, and in such a case the inconsistencies of differ- 
ing styles are most apparent. At this point, it is not intended to give 
more than the general principles that should govern in the matter of the 
preparation of reports. 

The working papers that accumulate during an audit should be care- 
fully made with pen and ink, on uniform paper. In handling numerous 
papers, a great economy of effort, and satisfaction in binding, are secured 
by the use of sheets as nearly the same size as possible. Analysis sheets 
should be provided with rulings sufficient for the construction of analytical 
statements. These papers are used as the basis of the report and should 
be arranged in order and filed carefully for future reference. The methods 
of preparing working papers vary with accountants, but hasty and careless 
work should not be permitted in any case. 

A report should usually be made in triplicate or quadruplicate, so 
that the client may be supplied with the original, signed copy, and one 
or two additional copies if desired, leaving one copy to be preserved by 
the accountant in a fire-proof file. 


9 


The legal responsibility of the accountant for certifications and rep- 
resentations contained in reports is not well settled in this country. He 
is unquestionably morally responsible for reasonable professional care in 
making such certifications, and, if the courts follow English precedents, 
will be held legally responsible as well. 

The accountant, in reporting upon any matter, should confine him- 
self to a presentation of the facts, and not express opinions unless they 
are specifically asked for, and then only with the greatest caution. Facts 
may be so presented as to leave but one conclusion possible, but as a 
general rule, it is better to allow the person to whom the facts are pre- 
sented to draw the conclusion. 


Distinctions in Terms. 


There is some confusion in the use of the terms accountant, auditor, 
accounting, auditing, and accountancy. 

The term accountant, or public accountant, is properly applied to 
the person who, having the requisite theoretical training and experience, 
offers his service to the public in the installation of accounts and systems, 
and in the making of appraisals, audits and reports. 

Under the Certified Public Accountant law of New York, the degree 
of Certified Public Accountant may be obtained by conforming to certain 
requirements, and other states have followed closely the New York legisla- 
tion, thus officially establishing the use of the term accountant. 

There is another use of the word accountant, describing a skilled 
bookkeeper engaged in private employment. To make a distinction, the 
word public is used in connection with the word accountant, giving the 
term public accountant, although with the growth of the profession, the 
single word accountant is coming to be accepted as descriptive of the 
professional accountant. 

In England and Scotland there are statutory provisions requiring 
that corporations, and certain other classes of undertakings, must have 
their accounts audited and certified by auditors, so that the term auditor 
is properly used in designating the person who performs such work. 

In this country the term accountant includes in its meaning the per- 
son who audits accounts. This is evidenced by the legislation providing 
for the degree of C. P. A., for the accountant will most frequently use 
his degree in certifying to facts determined through auditing work. 

There is a common acceptation of the term auditor as meaning one 
in charge of an accounting department, generally of a large corporation, 
such as a railroad company, but whose duties are private, and who cannot 


IO 


be called an auditor in the sense that a public accountant is sometimes 
called an auditor. 

The terms accounting and auditing apply to different branches of 
the accountant’s work, the former including the installation of accounts 
and systems, and the latter the making of audits and reports. 

The term accountancy is applied to the profession of the public ac- 
countant. The term accounting is sometimes used in this sense, but it 
is preferably used in referring to that part of the professional work of 
Accountancy that deals with the theory and practice of accounts. 

The name controller or comptroller, is often applied to the chief of 
the accounting staff of a large corporation, signifying, in many cases, a 
more responsible position than auditor. <A controller is often charged 
with the responsibility of planning and executing financial plans. The 
term is used especially in the case of large corporations with subsidiary 
corporations, each of which may have its own auditor. 


Verification. 


The meaning of the term verification, as used throughout this Lec- 
ture, is that the facts be established to the knowledge of the accountant — 
or his assistants. In the transaction of business the great majority of 
things must be accepted for what: they appear to be on their face. In 
the matter of verification of financial records, however, it is the duty of 
the accountant to go back of appearances, proverbially deceptive, and 
determine the facts that actually exist. It therefore becomes his par- 
ticular work to obtain and state facts and not to state opinions and im- 
pressions based upon appearances. 

It is true that there will always be matters not capable of absolute 
verification, and other matters of not enough importance to warrant a 
detailed verification, depending upon the circumstances of the particular 
audit, but in certain well known essentials, to be stated later, the veri- 
fication must be absolute. 

The principle of this is stated in the well known auditing maxim, 
take nothing for granted. When personal comfort tempts to the accept- 
ance of an item, the verification of which is essential, and which involves 
the tracing of a complicated transaction, the maxim must be heeded, for 
otherwise the very discrepancy that the audit is planned to guard against 
may go undetected. 











_ THEORY AND PRACTICE OF AUDITING 


By HOMER. SP. CLALR: PACH (Ge Puck. (Ni Ye) 


LECTURE II 
PROCEDURES 
Pee LEVER TPP Gly ei ee als GL) ee he Sete ean 11 
CHECKING THE BOOKKEEPING RECORD... .:.......0 80. 12 
COCK ING THE CASH NOOR Te! oN ye ea ee 15 
PT OORT esa con ee Cen ancy oops CU Cis 15 
RECONCILIATION OF CASH Meee or er US ROT a 17 
CHECKING THE JOURNAL....... Ag GTR ean ery 18 
CUECKING SUBSIDIARY BOOKS. chee) ae eae as 2. 19 


COPYRIGHT, 1915, By 
HOMER ST. CLAIR PACE 


PACE.& PACE 


PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


30 CHURCH STREET | NEW YORK CITY 


ode 
‘ 
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HAs 
Sai 





"THEORY AND Practice oF AUDITING 
By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE II 


PROCEDURES 


The Initial Steps 

In conducting an audit, the first essential is to obtain a correct idea 
of the accounting method employed, the name and uses of each of the 
books of account, and the names of the persons in charge of the various 
transactions, such as the receipt and payment of cash, the authorization 
of credits, the ordering of goods, etc. For this purpose, it is customary 
to require that a list of the books used, and of the names of the persons 
in authority, be furnished. The quickest way, however, to obtain such 
a list is for the accountant to prepare it himself. 

It not infrequently happens that the scope of the audit covers time 
in which two or more different sets of books were operated, or old ledgers 
have been closed and new ones opened, in which case it is best to have 
the periods covered by the different sets, or particular books, noted on 
the list. 

In the nature of things, the accountant is liable to be called in upon 
work the details of which are more or less unfamiliar to him, but, as a 
tule, it is inadvisable for him to devote considerable time merely to study- 
ing the conditions. It is much better to obtain the list of books, and with- 
out further ado begin on a portion of the work which in any event must 
be performed, and which will at the same time give the run of the busi- 
ness, and the uses of the books. This effects not alone an economy of 
time and effort, but produces a much better impression upon the client 
and employes than would otherwise be the case, an object worthy of some 
consideration, especially in new audits. 

The best field for this initial work is in the cash transactions. A 
scrutiny of the Cash Book, both by verifying all its additions, and by 
checking the original entries against the postings in Ledger accounts, 


will quickly indicate the general course of the business. 
Copyright, 1915, by Homer St. Clair Pace 


12 


Another method is to determine that the payments of cash, as re- 
corded by credit entries in the Cash Book, have been actually made as 
recorded. This is accomplished by requiring the production of receipts © 
for payments, called vouchers, noting the items for which direct receipts 
cannot be produced, and later verifying them, if possible, by other means. 
This is an essential part of the audit, and gives an immediate insight 
into the business. 

The choice between these two initial steps will depend upon the 
circumstances attending the particular audit, and the availability of the 
men for the work. The verification of cash payments, and the checking 
of additions, can be done advantageously by an accountant working by 
himself, while the checking of postings can best be done by two men work- 
ing together. The economical disposition of the auditing force largely 
determines the order of procedure, and it is a matter that can be worked 
out only with the conditions of the particular audit well in mind. 

In the detection of unintentional errors the accountant has to con- 
tend with nothing more than incompetency, which, while it requires a 
thorough knowledge of the theory and practice of accounting and audit- 
ing, does not present the difficulties involved in the detection of inten- 
tional errors, or fraud. 

The detection of errors of intent, or fraud, must be one of the objects 
of an audit, although the particular audit may not be especially instituted 
for that purpose. Therefore, the search for fraud must be unceasing, and 
as a preliminary measure, the duties of the members of the office staff 
must be studied in order to determine where fraud could most easily 
occur. In case the receipt and disbursement of cash is made by the same 
person, for example, the opportunity for fraud is greater than if the two 
functions are performed by different persons. Such a condition should 
be advised against. 


Checking the Bookkeeping Record 


A large part of the work of auditing consists in a minute scrutiny 
of the actual bookkeeping record in order to determine whether the ledger 
balances and statements accord with the facts recorded in the books of 
original entry, and whether alterations have been made for the purpose 
of covering fraud. 

It is usually understood that the work of auditing begins only when 
the accounting record is completed, and the books are in balance as evi- 
denced by a Trial Balance. In such a case the preparation of the Profit 
& Loss Statement and Balance Sheet may be made a part of the work, 


3 


although such statements may be prepared by the regular staff, in rough, 
and await the accountant’s audit for criticism and final approval. 

In a general way, considering the audit of books of account kept 
on the double entry principle, the accountant first determines whether the 
Balance Sheet, or in the place of the Balance Sheet, the Trial Balance, 
is in equilibrium. He then compares the Balance Sheet with the Ledgers 
from which it is made, checking the Ledger additions and the abstraction 
of balances, to see if it properly presents such Ledger facts, thus proving 
the equilibrium of the Ledger. 

It is then necessary to establish the agreement of such Ledger balances 
with the original records of the business, or at least such original records 
as are likely to disclose errors of consequence. For this purpose the entries 
in the Ledger accounts are compared with the entries in books of original 
entry such as the Cash Book and Journal. 

This comparison, most commonly called checking, and by British 
accountants called ticking, is generally made by two accountants, a 
senior, in charge of the audit, and a junior, who performs clerical work 
and acts as an assistant to the senior. 

The senior may handle the Ledger, and, verifying a particular ac- 
count, call back to the junior the detail of an entry. Thus, he may be 
working on the accounts of a customer and verifying the credits. Find- 
ing an item of $350 posted from the Cash Book on January second, he 
calls back the name of the account, date, Cash Book page and amount. 
This item the junior finds on the debit side of the Cash Book and repeats 
the amount. The senior thereupon checks the item in the Ledger accounts, 
and the junior checks the item in the Cash Book, the respective check 
marks indicating the comparison. 

It is necessary to exercise caution in calling back amounts in order 
to avoid errors. The work is rather tiresome, but unless it is done care- 
fully amounts to nothing. If an item of $350 is called back as three-fifty 
and the junior checks off a $3.50 item, the error might remain undetected 
so far as the calling back is concerned. Such an error is guarded against 
by stating in the case of cents the fact, thus—three dollars fifty cents. 

It is customary for accountants to use a personal check mark in order 
to recognize at any future time the work which they have done, and this 
may consist of an initial with some little peculiarity not easily apparent, 
but which the accountant invariably makes in order more readily to recog- 
nize his personal check mark. It is well, in addition, to use some kind of 
ink which is not in common use, in order to render a duplication more 
difficult, and, of course, this ink should not be made available to the book- 
keeper or other office employes. 


14 


If the senior finds that each entry in the Ledger account is duly posted 
from some book of original entry, his check marks will indicate that fact, 
but if any item cannot be traced to another book, it will be apparent 
through the absence of a check mark, and a notation is made to investigate 
the inconsistency. 

There are always bound to be matters which come up in the audit of 
accounts that, for the moment, cannot be satisfactorily explained, but 
upon full investigation, are found to be capable of explanation. It behooves 
the accountant to be careful in talking in regard to such apparent dis- 
crepancies until he has completed his investigation, for it is awkward to 
explain his first misunderstanding. 

In making notes, as the checking work progresses, of apparent dis- 
crepancies and matters to be more fully investigated, the accountant 
must exercise great care to make his notes carefully, and with sufficient 
detail to recall to his mind quickly the points involved. The making of 
inadequate notes, upon various sized slips and sheets of paper, and in a 
careless hand-writing, marks the inexperienced accountant. Failure to 
regard the necessity for care and neatness in this respect will bury the 
accountant with a mass of detail which will require for its proper use 
nearly as much work as its original preparation. The accountant makes 
speed by not having to perform the same work twice. This applies with 
even greater force to the preparation of statements, involving perhaps 
weeks of work, which must come out to an exact balance or reconciliation. 

Instead of the calling being made from the Ledger back to the book 
of original entry, it is sometimes desirable that the book of original entry 
be called back to the Ledger. In the case of the Cash Book, this would 
enable the accountant to see that every entry had been posted into the 
Ledger, and while it would complete the Cash Book, it would not com- 
plete the checking work of the particular accounts. It ordinarily consumes 
more time than the opposite procedure, although there are cases where 
it is desirable to do the checking in this way, particularly when it is desir- 
able to finish the verification of a book of original entry at one sitting, 
or while the record is in the possession of the accountant. 

The accountant must maintain a continual watch for erasures, and 
satisfy himself, where possible, that they were not made to conceal fraud. 
When passing over such erasures, he should especially check them with 
his private mark in order to safeguard himself as much as possible against 
erasures made after he has completed his work. So far as the accountant 
is able to control the making of the bookkeeping record, he should prevent 
erasures, instructing that transfers be made instead, or the erasure made 
by drawing red-ink lines through the work, so that the reason for the 


15 


correction will be apparent. This is a hard matter to accomplish, for no 
bookkeeper likes to have errors made so apparent, and he will ordinarily 
resort to an erasure. 

It is necessary to maintain a close watch for errors that result from 
carelessly made figures. As an example, ciphers and the figure 6 are often 
made very much alike, and errors in addition and posting may result 
therefrom. It is another illustration of the fact that the accountant must 
not be deceived by appearances, but go back of appearances and ascertain 
the facts. 

Good light and sufficient room in which to work are essential to the 
detection of erasures, the determination of carelessly made figures, etc., 
and should be secured wherever possible. Privacy is desirable, when it 
can be obtained, in order that proper concentration may be had upon 
the work. 


Checking the Cash Book 


All entries in the Cash Book must be checked in the manner which 
has been indicated, establishing its agreement with the Ledger. 

In calling back the Cash Book entries, all extraordinary items, espe- 
cially those large in amount, for which the reason is not apparent on the 
face of the books, should be noted for special investigation. On the debit 
side of the Cash Book, the receipt of insurance money, contributions of 
capital, etc., are unusual items which may render necessary special con- 
sideration. 

On the credit side of the Cash Book there may be extraordinary 
payments, not falling within the general run of the business, such as large 
purchases for the permanent plant of the business, extraordinary legal 
expenses, etc. 

The necessary explanation of these credit items will, as a rule, be 
found in the supporting vouchers when they are examined, and in case 
they do not supply the necessary explanation, the accountant must seek 
it elsewhere. In passing through the Cash Book, however, it is well to 
note these unusual items for further and particular investigation. 

In addition, a careful scrutiny must be made of all erasures, and 
notations made of the matters which require further explanation, and 
which might conceal errors or fraud. 


Petty Cash 


In nearly all cases it will be found that small payments, such as car- 
fare, express charges, stamps, etc., are made from a cash fund in charge 
of the cashier or other person entrusted with that work. The amounts 


16 


involved are ordinarily small, and it is not usual to attempt a verification 
of the details of the petty cash disbursements, further than to get an 
approval of the petty cash transactions by some responsible person. There 
are several ways of handling petty cash, the most common being to draw 
a check for a small amount, say $25, charging it to expense, and crediting 
Cash. When the fund is exhausted, another check is drawn, and so on. 
In case any part of the money is spent for an item not chargeable to ex- 
pense, a corrective journal entry is necessary, charging the proper account 
and crediting Expense. This rather crude method is complicated in many 
cases by the petty cashier ‘augmenting his fund by the small cash receipts 
as they come into the business, for which an entry is passed charging 
Expense and crediting the party from whom the money is received. A 
Petty Cash Book is sometimes kept to show in detail the transactions. 

The best method is known as the Imprest System, by which a round 
amount, say $25, is turned over to the petty cashier, charging him in 
a ledger account and crediting Cash. The amount is usually one that 
is estimated to be sufficient to cover the Petty Cash disbursements for 
a certain period, say two weeks, and at the end of the period, the petty 
cashier turns in a statement showing his disbursements, for which he 
receives a check, restoring the fund to the original amount. The amount 
of this check is charged in the Cash Book to such items, expense or other- 
wise, as are indicated in the statement. The amount charged to the petty 
cashier in the general ledger stands as a debit until the final surrender 
of the Petty Cash fund, when the cash received is charged, the amount 
of the final bill is charged, and the petty cashier’s account credited to 
balance. A Petty Cash Book may be used, showing in a debit column 
the cash received, and in distribution columns the various cash payments, 
brought into a total column. At the end of the period the excess of the 
cash receipts over the total payments is brought down as the opening 
cash balance for the new period. 

The accountant should endeavor to have the Imprest Petty Cash 
system adopted, and, in any event, must insist that no cash receipts of 
the business should be taken into the Petty Cash. Every receipt, no matter 
how small, should be deposited in bank, thus establishing an independent 
record of all moneys received by the business, and rendering it necessary 
for some one in authority to go on record, by means of checks, in dis- 
bursing it. The method of including petty cash receipts in the Petty Cash 
fund places in the hands of the petty cashier the receipt and payment of 
money, without the safeguard of such an independent record. 

It is well in making an audit to bear in mind that it is not practicable 
to verify absolutely all Petty Cash disbursements, and usually the best 


17 


plan is to admit this, and merely have the Petty Cash transactions ap- 
proved by some one who is in authority. In addition to this, every effort 
should be made to have the client adopt a proper cash system, providing 
for the deposit of all cash receipts in bank and for all payments to be 
made by check, with the exception of Petty Cash, to be run on the Im- 
prest System. 


Reconciliation of Cash 


Provided the amount of cash which was in the business at the be- 
ginning of the accounting period, and all subsequent cash receipts, appear 
on the debit side of the Cash Book, and provided all payments appear 
on the credit side of the Cash Book, the excess of the former over the 
latter will be the net cash balance. The checking of the Cash Book with 
the Ledger having established the fact that all debits and credits have 
been properly entered in the Ledger, the determination whether the under- 
taking actually possesses the amount of cash shown by the Cash Book is 
in order. 

The balance of cash shown by the bank at any particular time is 
likely to be greater than the amount shown by the Cash Book, owing to 
the fact that checks may be outstanding which have not been paid by 
the bank. Upon the return of the bank pass book properly written up 
and showing the cash balance, together with the paid checks, the out- 
standing checks are determined and their amount added to the balance as 
shown by the Cash Book. The result should exactly equal the amount 
of cash shown by the bank. This reconciliation has to take into account, 
of course, charges for printing of check books, collection of out-of-town 
checks, etc., and any credits which occur through allowances of interest, 
if any, on the balances. 

It might seem that such a reconciliation, supported by the pass book 
balanced by the bank, would justify the auditor in concluding that the 
amount of cash was actually in the possession of the concern. However, 
the pass book which is submitted to the auditor may not be genuine, and 
may have been prepared in different handwritings, and defaced to indicate 
usage, in order to imitate the real pass book. To guard himself against 
such a contingency, the accountant should receive a certificate from the 
bank, stating the cash balance as at the date in question. Many banks 
and trust companies have a regular form upon which to render such a 
certificate, and if they have not, a letter will answer as well. It is needless 
to say that the bank will not render such a certificate without request 
from the depositor, because otherwise it might put into the hands of un- 
friendly parties knowledge as to its depositor’s cash balance. It is best 


18 


to file the certificate away with the accountant’s memoranda of the 
particular audit, as it may be valuable in the future for evidence of the 
work he did in verifying the cash. 

Still another contingency which might exist, and which would not 
be disclosed by the mere reconciliation of the bank pass book with the 
Cash Book, is that the stubs of the outstanding checks might not indicate 
the true amount for which the checks are drawn, and, as a matter of fact, 
a check might be outstanding for which no stub whatever appeared in the 
check book. Such a condition would render valueless the certificate of 
the auditor as to the cash on hand. ‘To guard against this, the accountant, 
at a later period, and before he concludes his work, should have the pass 
book re-balanced, and at that time he will doubtless receive the paid 
checks corresponding to the stubs in the check book, and may consider 
his verification of cash complete. 

The foregoing verifies the amount of cash actually on deposit in bank- 
ing institutions. If there is an amount of cash on hand in the Petty Cash 
fund, or otherwise, it should be verified by actual counting, thus com- 
pleting the verification of all cash items. It is a common custom to do 
this immediately upon beginning the audit. 

The verification of payments by comparison of vouchers with the 
credit side of the Cash Book is a large and important subject and will 
be undertaken in another Lecture. 


Checking the Journal 


The Journal, in modern bookkeeping, is generally used only for open- 
ing and closing entries, summary entries, and entries not coming within 
the scope of such books as the Cash Book, Bills Receivable Book, Bills 
Payable Book, Purchase Book and Sales Book. In it any entry may 
be made, and for the purpose of an audit it is essential that every item 
be compared with the ledger account to which it is posted, the agree- 
ment of the two books being in this way established. Corrective entries 
and such important entries as the re-valuation of assets, etc. are recorded 
in the Journal, and any attempt to vouch the bookkeeping record with- 
out a careful scrutiny of these entries would be futile. 

If possible, it is well to finish the checking of the Journal at one sit- 
ting, or to keep the book in the possession of the accountant until the 
work is actually completed. It is necessary to use the same precautions 
in regard to checking the entries, scrutinizing erasures, etc., as have been 
suggested in checking the Cash Book. 


19 


The agreement of the Journal and Ledger having been established, 
authority must be sought for the various Journal entries. This will 
involve an examination of vouchers, contracts, deeds, and other docu- 
ments, and, like the vouching of cash payments, will be taken up in another 
Lecture. 


Checking Subsidiary Books 


The Cash Book and Journal must be checked against the Ledger in 
all cases, but it is not considered necessary ordinarily to make such a 
minute checking of the other books, unless circumstances exist that render 
a complete audit advisable. 

The same moral effect is obtained on the bookkeeping staff by a 
thorough checking of a portion of the purchases and sales transactions, 
the staff, of course, not knowing in advance what portion will be checked. 











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‘THEORY AND PRACTICE OF AUDITING. 


By HOMER ST. CLAIR PACE, C. P. A. (N..Y.) 


LECTURE III. 


VERIFICATION OF CASH. 


PEEPENITIONS. VS omc rEL ON. Vat Wn eee ig ae hie, We kai eae 


VoucHING CasH TRANSACTIONS.....:..... a Cs Mharieat es 
Voucuinc Caso RECEIPTS............ ach peru ats gic Ole Pen heey Oi 
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Meera OB OK he es ge De eee Cae ele 
Par CHEcks..... Do ogee alee NSO R EAD OER ECMO Sadie Baas UD md 

- PREPARATION OF VOUCHERS....... gh there pn Ene tons 

_ Inspection and CHECKING OF VOUCHERS. .......00. 00.0005: 
PAYMENTS FOR LABOR. yoo. So uae oe es Cee RD 
Prey Crea a Pm oe ee ens Diy cS eu ae 5 
Peele Parana  CPOA Sl Fase i Al ORME TN GER ree 
| COMPARISON OF PAID. CHECKS) .0 1 chile 0 oe. she ee 7 
Novation OE TRBEGUIARRAES Sn kOe NS oe ae aay Oe 


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.. COPYRIGHT, 1913, BY 
Homer Sr. CLraiR Pace, 





THEORY AND PRacTICE OF AUDITING. 
BY HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE III. 

VERIFICATION OF CASH. 


Definitions. 


The word vouch, a verb, means to uphold by satisfactory proof or 
credit. The word voucher, a noun, describes any material thing, such 
as a writing, tally, etc., that serves to verify an alleged act, especially 
one that certifies to the receipt of money or valuables. 

In accounting, a voucher, broadly, is a certification of the transfer 
of value, either received by the particular undertaking, or transferred by 
it to another. 

Its most common use is in the form of a receipt for money paid, 
taken in accordance with the usual business practice that requires a 
receipt, or voucher, for all cash payments. 

It is necessary in auditing to seek proof of many of the transactions 
recorded in books of account, by inspecting vouchers taken in support 
thereof, which, when signed by outside parties, constitute a valuable and 
independent means of verifying the record. 


Vouching Cash Transactions. 


The work of vouching cash transactions naturally divides into the 
verification of receipts, and the verification of payments. 

The vouching of receipts, to be complete, would take the form of 
an inquiry as to how much should be received, a determination of what 
appears of record to have been received, and what is still due to the con- 
cern, the latter two equalling the former. 

All receipts should be deposited in bank, thus establishing an inde- 


pendent record of cash deposited and disbursed. If this has been done, 
Copyright, 1913, by Homer St. Clair Pace. 


21 


the verification of payments takes the form of scrutinizing the disburse- 
ments as evidenced by the checks and supporting vouchers. 

In the natural order of things the receipts, presenting perhaps the 
more difficult proposition, should be considered first. 


Vouching Cash Receipts. 


In the ordinary commercial undertaking, the bulk of the cash receipts 
comes from the regular customers of the concern, and the only absolute 
verification would be to determine that every dollar which was properly 
chargeable to such customers had been duly charged, and all receipts 
duly credited. For this purpose an understanding with the customer 
would ordinarily be the best evidence of the regularity of the various 
charges and credits. This is, in many cases, impracticable, especially in 
the case of retail concerns, and the condition is sometimes tested by 
selecting a few of such accounts and obtaining their verification. 

Such a verification of customers’ accounts should only be under- 
taken with the approval of the client, and care should be taken to have 
the correspondence involved reach the accountant without the oppor- 
tunity on the part of the bookkeeper, or other interested parties, to 
tamper with it. 

In some cases, a complete verification of each customer’s account is 
necessary. In bank or trust company audits, it takes the form of secur- 
ing from each depositor an agreement as to the balance of his account. 

There is always the possibility of error or fraud on the part of the 
customer in stating the balance of his account, and this is a contingency 
which should be taken into consideration. A discrepancy merely indicates 
the necessity for further investigation, and may, or may not, prove fraud 
on the part of the bookkeeping staff. 

In the ordinary course in a business of fair size, the charges to cus- 
tomers are not made by the person who receives the cash. Therefore, 
if the receipts are not entered and properly credited, the rendering of the 
monthly statement is apt to provoke an inquiry as to the discrepancy. 

The cashier who appropriates a customer’s payment is, therefore, 
confronted with the necessity of securing a credit to the account of the 
customer, or failing in that, of holding off an investigation as long as 
possible by destruction of the regular statement, holding up correspon- 
dence, etc. 

The securing of the credit may be through a fraudulent Journal entry, 
charging a nominal account such as Allowances, or it may be through 


22 


the use of a late payment made by another customer, the account of 
the latter being adjusted from another collection, and so on. 

The fraudulent Journal entry is guarded against by the vouching of 
Journal entries, as will appear in due course. 

The lapping of payments, as it is called, meaning the appropriation 
of a receipt to be made good from later receipts, and so on, can of course 
be detected by verification of customer’s accounts; and frequently it can 
be detected from an inspection of the details of deposits. 

Thus, if the items deposited on any given day do not agree with 
the receipts, as evidenced by the various entries in the Cash Book, and 
such discrepancies cannot be explained satisfactorily, the condition indi- 
cates lapping. 

Thus, if Brown is credited with $260.50, and no item of that amount 
is found in the deposits, the natural inquiry is, In what form was the 
remittance received that there should be this divergence? Was it de- 
posited next day, or was it received part in cash and part by check? 

It is not likely that the subsequent payment would be the exact 
amount necessary to make good the amount taken, but a check is selected 
that approximates the amount and the difference is adjusted in cash 
deposited. 

In case of large cash receipts care should be taken that an amount 
is not carried over to be made good from the subsequent day’s receipts, 
and so on. 

If no duplicates of deposit slips are kept (which is a practice that 
repays the labor involved), and details are not given in the check book, 
the accountant may obtain an inspection of the original deposit slips 
on file in the bank, from which he can secure the details for the com- 
parison. In case details of such deposits are kept, he must safeguard 
himself against erroneous entries therein, made to deceive. 

In some classes of business, a formal receipt is issued for cash taken 
in, and in such cases a comparison of the stubs and receipts taken into 
the Cash Book is useful. 

From what has been said, it will be obvious that cash receipts are 
not ordinarily capable of the exact vouching possible in the case of pay- 
ments, and the accountant, with the main avenues of danger well in mind, 
directs his efforts to the circumstances of the particular work in hand. 

Receipts from cash sales often present more difficulty in verification 
than receipts from credit customers, especially where the cash sales are 
incidental and no adequate protective measures are taken. Thus, it may 
happen that a bookkeeper approves such sales and receives the cash there- 


23 


for. In such a case it should be recommended that a responsible person, 
other than the bookkeeper, be required to approve, by initialling or other- 
wise, the sales tickets. An independent test record of the amount so 
approved could be kept, and, in any event, the bookkeeper will feel that 
every amount so received is under the scrutiny of another person. If 
the slips are numbered, or duplicates kept, the accountant will have a 
fair opportunity to determine whether the proper amount of cash is carried 
into the accounts. 

In the case of cash sales that amount to a substantial part of the 
entire business, there are various methods in use to prevent fraud. The 
principle most often used is a duplicate sales record that can be used 
as a check on the cashier. The principle of the cash register, a common 
expedient, is to place the clerk on record in the presence of the customer. 

Attention is particularly called to the principle of internal check, by 
which work is divided and one employee becomes, to a considerable extent, 
a check upon his fellows. While it can be applied in small undertakings 
it is especially adapted for use in enterprises with large office staffs, in 
which the division of labor can be carried out to a degree not possible 
in smaller concerns. 


Vouchers for Cash Paid. 


A voucher for cash paid may be merely a receipt of the payee upon 
his own stationery, giving in detail the items for which the payment is 
made. This form of voucher is probably the most satisfactory, so far 
as evidence is concerned, but, owing to irregularity in size and shape, 
such vouchers are not as conveniently handled and filed as they would 
be were they uniform. This may be overcome to some extent by attach- 
ing each receipt to a back or cover, which folds to a uniform shape, and 
which is therefore more easily handled and filed. For convenience in 
referring to the vouchers, they should be numbered consecutively, and 
the number of the voucher is preferably shown against the payment in 
the book of original entry. 

A method in common use is for the concern making the payment 
to use a form of voucher showing at its head the name of the concern, 
as debtor, with blanks in which the name and the address of the creditor 
are to be inserted. In a blank space left for the purpose, the details of 
the payment are given with more or less minuteness, as the practice of 
the concern may be. It is a common custom not to enter into minute 
details, but to paste to the form of the voucher the original bills from the 
creditor, the total being the amount shown on the face of the voucher. 


24 


At the foot of the voucher is a blank form of receipt to be filled in with 
the name of the payee, and the amount of the payment, and to be signed 
by the creditor in full of the account as stated in the voucher above. This 
is the usual form of railroad voucher, to which are added blanks for ap- 
proval by different officers, distribution of charges, etc. 

Upon approval of the voucher for payment, a check is drawn for 
its amount, attached to the voucher, and sent to the creditor, who is 
supposed to sign the form of receipt, filling in date, and to return the 
receipted voucher to the concern making the payment. 

When the payment is made by mail, the receipt of a properly signed 
voucher may be delayed through the negligence of the party to whom 
the payment is made. In such a case the matter should be followed up 
and the voucher secured. There will always be exceptional cases, how- 
ever, in which the voucher cannot be obtained, and for evidence of the 
payment the auditor must fall back upon the canceled check by which 
the payment was made, or upon such other proof as he may be able 
to find. 


Voucher Check. 


There is still another form of voucher, known as the voucher check, 
which is a combination check and voucher, by the use of which the payee 
receipts for the items shown in the voucher part of the check. This en- 
larges the size of the check somewhat. 

The voucher check has the advantage of combining in one document 
the paid check and a statement of the item which it settles, the use of 
the check constituting a receipt for the particular items. In the case of 
the ordinary voucher, the payee may use the check without giving any 
receipt for particular items. The voucher check provides a satisfactory 
voucher for the payment it covers. 


Paid Checks. 


Ordinary checks, without such evidence of the items which they cover, 
are not considered satisfactory vouchers, for the reason that there is no 
evidence of agreement between the parties as to the items the payment 
liquidates. For example, a payment of $1,000 may be made with the 
idea that it liquidates a certain item, when, as a matter of fact, the payee 
may credit the amount for a different item, and hold the other item in 
dispute. Paid checks, however, are good secondary evidence, and should 
be relied upon in ordinary cases, when, for some apparently good reason, 
the voucher itself cannot be traced. 


25 


Preparation of Vouchers. 


The work involved in the auditing of vouchers will depend largely 
upon the care with which the vouchers have been kept, their arrange- 
ment, and their richness in detail. 

It is not uncommon to find them lacking in all these points, and 
valuable time is necessarily spent in arranging them for inspection. In 
the case of regular audits, the bookkeeping staff should be impressed 
with the necessity for keeping proper vouchers, to be arranged for speedy 
inspection by the accountant. 


Inspection and Checking of Vouchers. 


With the vouchers for general payments thus arranged in order, 
each voucher should be compared with the entry in the book of original 
entry, usually the Cash Book, to determine whether it constitutes a gen- 
uine receipt for the amount of money paid, and whether the items it 
covers are legitimate. 

This involves a scrutiny of the signature, which should bear the 
appearance, through stamps, handwriting or otherwise, that it is genuine. 
The accountant does not in ordinary cases verify absolutely the authen- 
ticity of the particular voucher, but keeps a lookout for suspicious cir- 
cumstances, investigating fully in such exceptional cases. 

The items covered must be studied with a view of detecting fraud. 
For example, a voucher in a corporation for legal expenses, without 
further explanation and to a person other than the regular attorneys, 
or in an exceptional amount, would call for a fuller investigation. Such 
a voucher might cover an erroneous payment to the directors. The cir- 
cumstances of the particular audit must govern the accountant largely 
in this matter of scrutiny, for a certain class of transactions may be open 
to greater suspicion in one audit than in another. 

An accountant cannot be held to the absolute determination .of sig- 
natures upon vouchers, because, in the nature of things, he cannot know 
all of the signatures that come before him upon vouchers. However, a 
careful inspection of the documents often leads to the detection of fraud, 
and the accountant should be expected to take advantage of every clue 
that can be detected by a reasonable inspection of the vouchers and 
related records. 

It is not usual to check the additions and other calculations in the 
vouchers, although there may be cases where such checking is necessary. 

If the voucher appears regular, the accountant checks with his per-_ 
sonal mark the item in the Cash Book which it covers, and indicates on 


26 


the voucher, in a conspicuous place, where it can be seen without opening 
the voucher, the fact of its having been examined. This can be done 
by a rubber stamp with the accountant’s initial, or by the initial alone. 
It is necessary that this be done in some permanent manner in order that 
the voucher may not be produced again, and possibly passed in panbees 
of another payment. 


Payments for Labor. 


In addition to the general payments, large disbursements will ordi- 
narily be found for wages. These items are likely to occur at regular 
intervals, and in fairly regular amounts, and any deviation from such 
regular order indicates a condition to be investigated. 

_ In the ordinary audit, it is not considered necessary to verify abso- 
lutely the payment of wages to laborers, and indeed, such a verification 
might in many cases be impossible. 

The greatest safeguard that can be devised in the disbursement of 
the large sums involved in wages, is to divide the work of time-keeping, 
preparation of pay-rolls or wages books, and the actual payment, in such 
a way that collusion is necessary for fraud. Therefore, in the case of a 
regular audit, the accountant should study the situation and devise such 
methods as will, in the particular case, furnish automatic safeguards by 
such internal check. 

In conducting an audit, the pay-rolls or wages books should be ex- 
amined, all footings therein verified, and sections of the work verified in 
detail. It is not practicable ordinarily to go back of this and trace the 
actual receipt of cash by the individual laborer. 

In the case of a continuous audit, a checking at the time of each 
audit of a portion of the pay-rolls in detail produces upon the bookkeep- 
ing staff the moral effect of a complete detailed checking, in that the 
staff cannot be sure which portion of the work will receive the critical 
examination of the accountant. 


, Petty Cash. 


Vouchers are ordinarily not taken for petty cash disbursements, and 
the accountant usually contents himself with the certification of the petty 
cash transactions as a whole, as has been explained. However, an ccca- 
sional investigation and detailed checking of the petty cash transactions, 
where it is practicable, results in care on the part of the petty cashier. 

In rare cases, large sums are handled and disbursed in cash on the 
Imprest system, in which case the payments would be verified by vouch- 
ers in the ordinary way. 


27 


Bills Payable. 


In the case of the payment of Bills Payable, Bond and Mortgage, 
etc., the paid instrument, of course, furnishes the best evidence that the 
payment has been made. 

In the purchase of securities for which payments are made, these 
securities should be available, or if they have been disposed of, that fact 
will be traced in its proper order in considering the acquisition and dis- 
position of assets. 

The securities that are acquired in this way should be inspected to 
see that they are authentic and transferred to the owner, or in shape for 
such transfer. This is a matter for more detailed consideration later. 


Comparison of Paid Checks. 


Paid checks should be compared with their respective stubs in the 
check book, to determine whether each check and its stub agree as to 
payee and amount. Paid checks should also be compared with the vouch- 
ers, either as they are checked against the Cash Book, or other convenient 
time, to see whether they agree. 

It is evident that merely an agreement of the Cash Book payments 
with vouchers, or Cash Book payments, vouchers and check stubs, would 
not guard against the passing of a fraudulent voucher upon the accountant 
in order to cover a payment to a person other than the one named in 
the voucher or the check stub. For example, the check stub, voucher 
and Cash Book entry may disclose a payment of $100 to John Doe, while 
the check itself may be drawn to Richard Roe, and by endorsement, show 
that he, instead of John Doe, received the money. 

The endorsements on the paid checks should be examined, for evi- 
dence might develop that the person to whom the check was drawn did 
not receive the amount thereof. 


Notation of Irregularities. 


In performing all of this verification of cash payments through the 
inspection of vouchers, it must be remembered that a keen outlook must 
be kept for irregularities of every nature, and particularly the irregular- 
ities which the circumstances of the particular audit indicate are most 
likely to occur. As the work progresses, notations should be made of 
matters which require further investigation, and, as these matters are 
investigated, the ones that are cleared up are checked off from the nota- 
tions, leaving finally the ones that cannot be satisfactorily explained, 
and which, with all the information collected in regard thereto, will have 
to be set forth in the accountant’s report. 








_ THEORY AND PRACTICE OF AUDITING. 


‘By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


‘LECTURE IV. 


JOURNAL AND OTHER VOUCHERS. 


/ Daw JOURNAL. @ 0) 6 Boor Sart ated begs Teas 
Peay MOREE SN eer ae 

- OTHER JOURNAL ENTRIES..... 

| “VOUCHER REGISTER.. 

SALES AND PURCHASE RECORDS. 


BILLS RECEIVABLE AND IBIELS ae Boos woth se 


In GENERAL. pee ha 
Bein OF PREVIOUS BALANCE SHEET... 


ey Avort Or PARTNERSHIP ACCOUNTS. . 

| ‘ PARTNERSHIP PROFITS... 

ny n PARTNERSHIP CAPITAL Covi ueaNS. 
is CompEtinG BusINESss. 

é - PARTNERSHIP oonatee: rene are 


CoPYRIGHT,. 1913, BY | 
Homer St. CLair PAcE. 


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THEORY AND PRACTICE OF AUDITING. 


BY“HOMER ST. CLAIR PACE, C. P. A..(N. Y.) 
LECTURE IV. 


JOURNAL AND OTHER VOUCHERS. 


In Review. 


A detailed audit involves so many steps that it is desirable, at this 
point, to recapitulate and view the audit as a whole in order not to lose 
the relation that each part of the work bears to the other parts. 

It was shown that it is necessary to establish the agreement of the 
Trial Ba'ance or Balance Sheet, submitted as the basis of the audit, with 
the Ledger, and to establish the accuracy of the footings in the Cash Book 
and other books of original entry. This is preliminary to the establish- 
ment of the agreement of the Ledger postings, used as a basis for the 
Balance Sheet, with the chronological record kept in the books of original 
entry. 

_. The entries in the books of original entry constitute the vital account- 

ing record, and the one of greatest weight as evidence in court. The 
problem involved in auditing, therefore, is to see that the subsidiary 
records and statements are in accordance therewith, and, further, to see 
that such original entries are complete in themselves, free from errors of 
technique and principle, and that no fraud has been committed. 

The possibility of fraud is ever present, and is most likely to occur 
through the wrongful appropriation of the asset Cash, which is liquid in 
its nature and the conversion of which leaves fewer traces than would 
the conversion of other assets. Therefore, attention is first directed to a 
verification of cash on hand by counting the money, listing checks and 
drafts, and reconciling the bank balances. The cash receipts and pay- 
ments for the period under review are then verified, as has been explained 


Copyright, 1913, by Homer St. Clair Pace. 


29 


in detail, and a reconciliation effected between cash on hand at the begin- 
ning and at the close of the period. 

In a general way, this covers the scope of the preceding lectures, 
and clears the way for a consideration of the means necessary to verify 
the entries in the other books of original entry. 


The Journal. 


In the broadest sense, the Journal comprises all the books of original 
entry, but the term, as applied to a specific book in modern accounting, 
describes the one in which opening, closing and extraordinary entries are 
recorded. Therefore, while the entries are not numerous they are likely to 
be of importance, and always demand a complete verification in an audit. 

All Journal entries must be checked against the respective Ledger 
accounts and the agreement of the two books established. Errors of 
technique, wrong postings, etc., may be corrected by the accountant as 
he proceeds. Errors of greater consequence, and matters that require a 
fuller investigation, should be noted in the working papers. 

. Journal entries, like those contained in the Cash Book, should be 
supported by vouchers, although the form is likely to differ from that 
of the vouchers supporting cash transactions. Instead of duplicate sales 
slips, deposit slips, receipts, paid checks, etc., common to the verifica- 
tion of Cash, the vouchers are more likely to be in the form of approval, 
by persons in authority, of entries involving transfers or allowances, or 
in the form of contracts, deeds, or other instruments the execution of 
which presupposes and renders necessary a Journal entry. 


Allowances. 


Bills are frequently settled for less than their face, either by regular 
discount, which, in modern books, passes through the Cash Book, or by 
allowances on account of faulty goods, difficulty of collection, or otherwise. 

The passing of allowances is an important matter, ordinarily entrusted 
to a partner or some one in authority. No allowances should be entered 
in the Journal or otherwise without the written authority of the person 
who is charged with this important duty. Therefore, when such practice 
is in effect, no Journal entry, constituting a charge to a nominal account 
and a credit to a customer’s account, may be made without supporting 
authority available for the accountant’s inspection. 

Without the requirement of such formal authority, it is possible for 
a bookkeeper, who has appropriated a cash receipt from a customer, to 
pass a Journal entry, charging a nominal account and crediting the cus- 
tomer’s account. The effect of this is to set up a loss instead of increasing 


30 


the asset Cash. The customer’s account shows the proper balance, so 
that, even though another clerk renders the statements, the fraud is not 
likely to be disclosed. If such a credit were not made and a statement 
were rendered, the discrepancy would probably lead to an inquiry from 
the customer and consequent exposure of the fraud. 

The accountant should insist upon the production of the proper 
authority, and inspect it carefully. He must bear in mind that forged 
authority may be shown him, and therefore he must be thoroughly 
acquainted with the signature or initials of the person in authority; and 
when an allowance seems unusual or out of the ordinary it is a matter 
for special investigation. 


Other Journal Entries. 


The purchase price of real estate can usually be determined by an 
inspection of the contracts, deeds, and other papers in relation thereto, 
and any expenditure necessarily incurred in its acquisition, even though 
it is in the nature of broker’s commissions, abstract fees or legal expenses, 
may properly be passed as an asset. 

In the case of partial payments, it is necessary to see that the full 
asset value is carried in, and the lability on account of payments still 
to be made, set up. Care must be exercised to see that interest upon 
unpaid instalments is not charged as an asset. 

The Journal entries may be rich in explanatory detail, but in any 
event an inspection of the original contracts or instruments is safer. The 
Journal may contain only such clauses as the management may desire to 
have appear, while the actual contracts may disclose facts of importance, 
affecting the financial standing of the concern. 

In vouching Journal entries great care must be exercised to deter- 
mine the basis of valuation, which will require the consideration of con- 
tracts and other data. 

Transfers between Ledger accounts must be scrutinized, and when 
the reason therefor is not entirely apparent, an investigation must be 
made to clear up the doubt. Failure to investigate such a transfer may 
leave fraud undetected, as where a credit is erroneously made to a cus- 
tomer’s account and another account charged. 

The revaluation of assets, which would be recorded in the Journal, 
raises many questions to be investigated. For example, the determina- 
tion whether or not it is based upon the estimate of reliable and inde- 
pendent appraisers, or upon the mere caprice or opinion of the manage- 
ment, and the ultimate effect of the adjustments, are matters of import- 
ance. In case of an increase, the resulting credit may be used to offset a 


31 


debit to Profit & Loss, or erroneously to increase the net results of current 
operation. Abnormal conditions of this kind should be set forth in the 
accountant’s report. 

An accounting record should contain all the facts necessary to state 
the financial history and condition of the particular enterprise. There- 
fore, a comprehensive view of the business itself is necessary to guard 
against errors of omission. For example, the failure to include a loss 
and the liability therefor, as might be the case with rent, wages, etc., 
would be an error of omission, and is one that should be detected by the 
accountant. Even more difficult to detect and include are the indirect 
expenses of depreciation, or the wasting of asset value through use, effluxion 
of time or obsolescence, the estimated losses upon collection of accounts 
receivable, etc. 

The inclusion of all items necessary to the correct determination 
of profit and loss and financial position, raises vital questions of principle, 
to be discussed later. At the moment, the authority for entries is in ques- 
tion, and in these matters of principle the accountant himself is the author- 
ity, and he cannot relieve himself of the responsibility, in case he certifies 
to profit and loss outcome and financial condition, of passing upon such 
entries. 

Any entry may be made in the Journal, so that all principles of veri- 
fication, cash or otherwise, may be necessary in its treatment. 


Voucher Register. 


The voucher register is employed as a book of original entry to record 
liabilities on account of purchases, and it may include liabilities incurred 
for other items, such as rent, cartage, etc. A document known as a 
voucher, heretofore sufficiently described, is used for the collection of the 
items for whch a credit is to be made, and the various bills and docu- 
ments are attached thereto. There are blanks for approval by persons in 
authority. Thus, a voucher may be approved for entry, while another 
approval may be necessary before it is actually paid. 

This systematic collection of data in relation to a particular bill, and 
its formal approval, is a condition that aids the accountant in his work 
of verification. A close scrutiny must be maintained, however, especially 
in regard to items that are exceptional in their nature. 

The credit balance of the Unpaid Vouchers Account represents the 
liability on account of vouchers entered, and should be checked against the 
unpaid vouchers in the office. As in the case of the omission of liabilities 
where the voucher register is not used, it is necessary to determine that 


32 


all proper liabilities are included; therefore, they must appear either in 
the Unpaid Vouchers Account or in some other account that will record 
the liability. 


Sales and Purchases Records. 


A complete detailed audit involves the verification of sales and pur- 
chases, although, in practice, this is not always done. 

Considering sales, there would remain after the cash audit, only 
the sales on credit. The original record will be in a sales book, or some 
form of it, supported by the original orders turned in by salesmen or 
received in the mail. The additions of the sales record eos proved, the 
entries are checked against the proper ledger. 

The orders from salesmen may be of importance in determining that 
proper commissions have been credited to the respective salesmen. In 
some undertakings, commissions are credited or paid only upon the pres- 
entation of customers’ orders. 

In the matter of purchases, the duplicate orders, usually kept as 
a part of the office routine, support the purchase record, and they may 
be of value in determining that credits are being made in accordance 
with orders given. Collusion between a clerk and a creditor is possible; 
hence the duties of order clerk, receiving clerk and bookkeeper should 
be performed, where practicable, by different persons. In case the orders 
were given, invoices approved and entry made by the same person, the 
order record would not be particularly valuable evidence of the authen- 
ticity of the purchases record. 

Returned sales and purchases involve entries that should be vouched 
by some one in authority. The vouchers should be inspected and any 
discrepancies noted. 

Returned sales, which involve credits to customers, should be sup- 
ported by evidence from the receiving clerk that the goods are received 
in due order. Such credits are in the nature of allowances and are im- 
portant for the reasons stated in dealing with that subject. 


Bills Receivable and Bills Payable Books. 


The transactions in Bills Receivable, other than payments or dis- 
count operations recorded in Cash, are likely to consist of the receipt of 
notes in settlement of open accounts, or in renewal of other notes. It is 
essential that the proper account receives credit. The renewals call for 
closest inspection, for uncollectible accounts may be carried indefinitely 
in this way, and in a case that looks suspicious on its face, the accountant 
should not be satisfied with anything less than an adequate explanation. 


33 


In certain phases of auditing it is sometimes found that advances of cash 
to relatives or friends, without proper authority, are carried in this way. 

Bills Payable are most often given for money, in settlement of open 
accounts, or in renewal. It is necessary to determine that the notes were 
properly issued, and to see that proper offsetting debits were made, either 
of asset or benefit received or liability liquidated. Great care must be 
exercised to determine that all of the bills and notes given are carried 
into the accounts. For example, under a contract for $10,000, bills were 
rendered, approved and entered for $3,000. Subsequently, the contract 
was completed and the bill for the remainder did not appear in the-office. 
A check for $3,000 was given in the office and a ninety-day note for 
$7,000 given by one in authority without the knowledge of the office 
staff. A consideration of all the contracts, and an understanding with 
creditors as to balances, brought to light this and similar cases. In such 
a case, however, the accountant would be cautious in giving his certifi- 
cate, qualifying it to take care of conditions possible under such ineffi- 
cient office management. 

Deliberate fraud would be still harder to guard against, for while 
inadequate records hamper the work of the accountant, in the absence of 
fraud the sincere co-operation of the client and entire office staff can 
usually be secured. 

It is hardly necessary to say that a properly kept book of blank notes, 
with all stubs accounted for, and an assurance that no notes were other- 
Wise issued, constitutes an ideal, but unusual, condition. Many notes, 
notably those given to secure the payment of property bought upon the 
partial payment plan, are of a special form, and are brought to light 
through the inspection of contracts. 

The general fact is that the verification of bills payable is a difficult 
matter, and the illustrations are given to make clear the fact that the 
records, including many documents and letters, must be studied in order 
to disclose all of such evidences of indebtedness. 


In General. 


There may be other original records, but the lines of voucher verifi- 
cation have been sufficiently noted. 

Happily, fraud is the exception and not the rule. It is always pos- 
sible, however, and it is the accountant’s duty to prove that the account- 
ing record is correct and, therefore, that fraud does not exist. If fraud 
develops, it is a flaw in the record, to be presented and treated as the 
case requires. 


34 


No matter what confidence may be placed in an employee, the ac- 
countant should not trust to such confidence in lieu of obtaining facts. It 
must be remembered that defalcations are rarely committed by persons 
in whom confidence is not placed. 

The utmost tact is required in conducting an audit in order to obtain 
the co-operation of clerks and to avoid their antagonism. By gentle in- 
sistence, the facts may be developed. If certain information 1s not pro- 
duced, the accountant should ask again and again until he secures it. It 
is not best to be peremptory upon the first request for an honest employee 
may be angered or a dishonest one put on his guard. A repeated and 
persistent refusal upon a vital matter is suspicious in itself, and, with 
proper handling, may bring to light facts of importance. 


Verification of Previous Balance Sheet. 


It has been stated that an audit covers the verification of an account- 
ing record from a prior authenticated position to a subsequent time, and 
that, ordinarily, the verification does not extend to a point prior to such 
first position. It is necessary, however, for the accountant to determine 
that the facts as set forth in such prior Balance Sheet agree with the facts 
in the Ledger as at the same date. Otherwise, the basis, that is, the pos- 
session of assets and the amount of liabilities which are standing in the 
Ledger and which serve as a basis for the work, may not, as a matter 
of fact, be the prior authenticated financial position as disclosed in the 
Balance Sheet. 

In the case of a new audit, it would ordinarily be unwise to certify 
to a Balance Sheet that had been verified only to the extent of an audit 
of the last accounting period, and an acceptance of a Balance Sheet which 
had been verified at the beginning of the accounting period. It must 
be remembered that reliance will be placed upon the accountant’s certifi- 
cate that the assets and liabilities of the undertaking are as stated in 
the Balance Sheet, and the accountant cannot escape at least the moral 
responsibility for error, if the assets and liabilities are not, as a matter 
of fact, as stated. 5 

It will, therefore, be necessary for the accountant to satisfy himself 
that the assets are valued in accordance with sound accounting principles, 
and for this purpose it may be necessary to trace them back to their acqui- 
sition, and to determine that adequate provision is made for depreciation, 
losses upon collection, etc., or in the absence of such provision, to state 
that no such provision has been made. It is not always possible for an 
accountant to prevail upon his client to provide sufficient reserves for 


35 


depreciation, losses upon collection of book accounts, etc., but in his 
certificate he may at least state just what action has been taken. 


Audit of Partnership Accounts. 

The points of difficulty that ordinarily arise in the statement of 
partnership accounts are in respect to division of profits and adjustment 
of interest upon capital contributions, and therefore engage the atten- 
tion of the accountant in his verification and report. 

As a basis for such an audit, the partnership agreement should be 
secured. If properly drawn, it will furnish the guidance that the account- 
ant needs. The partnership agreement will be but temporarily in the 
possession of the accountant, and, in perusing it, careful and full notes 
of the most important provisions should be made for future reference. 

If any of the provisions affecting the statement of the accounts are 
not clear, an understanding should be had between the partners, and 
preferably reduced to writing, and the matter should then be handled 
in accordance with such understanding. | 

In the case of a verbal partnership agreement, any doubtful matters 
affecting the interests of the respective partners should be taken up with 
the partners at a meeting at which all are present, and at which an under- 
standing upon the points in question should be obtained. The accountant 
should make notes of the understanding and make his adjustments accord- 
ingly. Great reliance is placed upon the accountant’s judgment in many 
cases, but he must not undertake the responsibility of making agreements 
for his clients and giving effect to them in the books of account. His work 
is merely to carry the agreement, when made, into effect in the accounts. 

In the absence of agreement, interest is not allowed upon capital con- 
tributions nor upon withdrawals, and it does not follow from an agreement 
to allow interest upon capital contributions that it is to be charged upon 
drawings. The profits, in the absence of agreement, to the contrary, are 
shared equally, irrespective of the capital or services contributed by the 
respective partners. 

In crediting partners for interest upon capital, the entry is carried 
out even though no profit has been earned. This is necessary to give effect 
to the agreement and to bring the capital accounts to a point where they 
measure the interests of the respective partners in the assets of the firm. 

In the case of charges to partners’ accounts for interest upon with- 
drawals, the credit is carried to a final division of the Profit & Loss Ac- 
count to distribute the effect. In the case of interest upon contributions 
the amount is carried to the final division of Profit & Loss as a debit. 


36 


The debits and credits, although carried to the Profit & Loss Account 
to secure the proper distribution, do not represent an expense or profit of 
the business, but merely an adjustment among the partners for unequal 
contributions or withdrawals, and therefore should be excluded from a 
statement prepared to show the net earning capacity of a partnership. 

Salaries drawn by a sole trader, or by partners, are usually in antict- 
pation of profits, and are not treated as an expense in determining net 
profits. If it should be desired to ascertain the amount of net profit 
available for dividends which could be obtained by a corporation organ- 
ized to carry on a business formerly conducted as a partnership, it would 
be necessary to take into account an amount sufficient to cover the value 
of the services of officers who would perform services equivalent to those 
formerly rendered by the partners. 


Partnership Profits. 


The rule of partnership law is that, in the absence of an agreement 
to the contrary, profits are considered as of the period in which they are 
actually realized, and not as of the period in which they are earned. This 
means that in a statement of partnership accounts no partner is compelled 
to accept as a profit any unrealized asset, but only to accept cash upon 
realization. 

The accounting rule, of course, is to consider profits as of the period 
in which they are earned, even though unrealized. Thus, if $5,000 of cash 
is exchanged for $5,000 of merchandise, and the latter for $8,000 of ac- 
counts receivable, the $3,000 excess of the amount of accounts receivable 
over the amount of the merchandise, less the expenses and a reasonable 
provision for loss on collection, is considered profit. It is apparent that 
such a profit consists of accounts receivable, and being unrealized, the 
amount which will be realized is to some extent speculative, and therefore 
should not be forced upon a partner. 

The apparent conflict between the accounting practice and the law 
is Overcome by the agreement of the partners. If the usual accounting 
procedure is carried out, and the results accepted by the partners, either 
tacitly, as a matter of custom, or expressly, by the signing of the new 
balance sheet, it amounts to an agreement that the interests are as stated, 

In the absence of such implied or express agreement the legal rule, 
as given, applies. 

Therefore, in the audit of partnership accounts involving the prepa- 
ration of statements, an express agreement as to the respective interests 
should be obtained, either by written contract, or, as is more usual, by 
the signing of the balance sheet which is prepared. 


37 


Partnership Capital Contributions. 


Care should be exercised by the accountant conducting a partnership 
audit to see that contributions of capital are treated as capital, and not 
as advances, and that in the case of the contribution of property the 
value, whether it is an amount arbitrarily fixed and agreed upon, or in 
the absence of such agreement, the realized value, is credited to the cap- 
ital account of the contributing partner. 

On the other hand, equal care must be exercised to see that amounts 
which are advanced as loans, and not as capital, are not carried to cap- 
ital, as such advances have priority over capital in liquidation. 


Competing Business. 


A partner must account for profits which he makes in any under- 
taking which competes with the partnership business, and in conducting 
an audit the accountant must watch for evidence of such competition. 
Even when it is found it may be a matter which is understood by all the 
partners, and therefore not a subject for special report. 

A special investigation is frequently made in partnership settlements, 
with the detection of such competition, and its results, one of its principal 
objects, and in such a case it assumes vital importance. 


Partnership Good-will. 


There are other matters of importance in the examination of partner- 
ship accounts, among which may be mentioned the question of Good-will, 
which is especially likely to raise at the time of the dissolution of a part- 
nership through death or otherwise. 

In many cases, the partnership agreement, which is the vital instru- 
ment in stating and limiting the rights and duties of the respective part- 
ners, will supply the information upon which the adjustment of the Good- 
will is made at the termination of the partnership. The subject is to 
be considered elsewhere and at this point it is sufficient to call attention 
to the importance of the partnership agreement in determining the course 
of the accountant in the examination. 


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THEORY AND PRACTICE OF AUDITING. 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


LECTURE. V: 

REPORTS. 
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CoPYRIGHT, 1913, BY 
HomMER St. CuatR Pace, 





THEORY AND PRacTICE OF AUDITING. 
De bnoOMER St CUAIK PACH Cl ry A. (Ni ¥.) 
LECTURE V. 

REPORTS. 


Definitions. 


A report is a statement or presentation of facts in respect to a par- 
ticular audit, examination, investigation, or subject. 

An opinion is a professional conclusion or judgment, to a considerable 
extent based upon known conditions or facts, but falling short of certainty. 

The distinction should be well understood, for the accountant, unless 
otherwise instructed, merely states the facts disclosed by his work in 
auditing, uncolored by his own opinions, conclusions, or judgment. 

In giving an opinion, when called upon for that purpose, the account- 
ant should proceed with the conservatism that will alike safeguard his 
own reputation and prevent ill-considered action upon the part of his 
client or others depending upon his judgment. The matters directly 
connected with the installation and operation of accounting systems and 
business organization are peculiarly within the province of the account- 
ant, and are fit subjects for opinions and recommendations. 

The accountant is often requested for an opinion as to future profit 
and loss outcome, based upon past results, probable production, markets, 
etc., to be used for the purpose of influencing investors and others. In 
such a case it is well for the accountant to content himself with a state- 
ment of facts as to past results, and allow others, if they choose, to deal 
in prophecies over their own names. The young accountant, in particular, 
before making estimates of future revenue, should first, for a period of 
years, note the percentage of cases in which, for unforeseen and unfore- 
seeable reasons, expected income fails to materialize. 

This Lecture is designed especially to state the principles involved 
in the presentation of accounting facts in reports. 

Copyright, 1913, by Homer St. Clair Pace. 


39 


Principles of Presentation. 


The presentation of a whole thought or idea, in the attempt to convey 
an understanding of facts, is better, even though it be in condensed form, 
than the presentation of a part of such thought at a time. This is especially 
true in accounting, owing to the difficulty of imparting a knowledge of 
conditions from figures. 

Thus, it may be said that a man has a capital, or worth, of $100,000. 

If it is stated that he has $50,000 of personal property and $50,000 
of real property, making a total of $100,000, the information is amplified. 
Observe, however, that if the latter statement were made independently of 
the first, there would be steps in the conveyance of the whole idea. Thus, 
the statement “he has $50,000 of personal property,’ by itself imports 
but a part of the facts as to financial position. 

It may be that the personal property is divided into $25,000 of mer- 
chandise, $15,000 of accounts receivable, and $10,000 of cash, and that 
the real property is divided equally between country and city holdings. 
The main fact as to financial worth thus develops into detail without 
great effort on the part of the reader. Nevertheless, one who reads no 
further than the first paragraph, stating the worth to be $100,000, has 
a complete idea, although meagre in details. 

If the items were numerous, say 50 or 100, or more, the mind could 
not carry their relative weights, and, pending the achievement of a total, 
a confusion of ideas and facts would exist. 

The main fact and its amplification may be presented in a graphic 
way to show the development, thus: 


Merchandise....... $25,000 
Personal Property $50,000} Accts. Receivable... 15,000 
Cash. 73:2 Aa eee 10,000 
Worth $100,000 
Country) .):..) hee $25,000 
Real Property... $sojoooiCity <3 5 yee eee 25,000 


The presentation is complete at each stage, and the reader may pass 
on to details, or not, as he chooses. The analysis can be carried still 
further by a division of merchandise into classes, accounts receivable 
into desired groups, cash into different bank accounts, etc. 

This principle is applicable to the presentation of facts in English 
without figures. For example, it has been stated that— 

Accounting is the science of recording facts in relation to property 
rights. 


40 


Amplifying this basic statement, we may say that— 
Accounting is the science of recording and stating facts in relation 
to the acquisition of property rights or values. 


Still further amplifying the statement, we may say that— 


Accounting is the science of recording and stating facts in relation 
to the acquisition, production, conservation and transfer of property 
rights or values, known as assets. 


From this point, it may be shown that the recording has to do with 
the accounting records and the stating has to do with forms of statements 
to disclose results; and the various other essential words may be used 
as texts for detail extending, if desirable, into volumes. 

The method of stating a fact and developing it by supporting state- 
ments, and still further statements, is useful for many purposes. The 
“supporting statements are said to articulate or join into each other, 
although the word does not satisfactorily give the idea of an expansion 
of detail in statements arranged in a logical order of fact development. 


Principles Applied to Receipts and Payments. 


An audit, and the report thereon, may deal with a particular phase 
of the accounting record, and not cover a complete detailed verification. 
The most common illustration of this is known as a Cash audit, which is 
that part of an audit that has to do with the verification of receipts and 
payments of cash. 

The presentation of the results of such a special audit will now be 
undertaken for the purpose of illustrating the principles that have been 
stated. 

A Statement of Receipts and Payments, or as it is sometimes known, 
a Statement of Receipts and Disbursements, is merely a record of the 
incoming and outgoing of the asset cash, presented with such degree of 
detail as the particular case may demand. 

It may be assumed that a theatrical enterprise had four companies, 
A, B, C and D, presenting plays during the months of October, November 
and December, 1902. During the month of October, the receipts of A 
were $20,000, of C $10,000, and the other two companies had no receipts. 
During the month of November, the receipts of A were $11,000, B $10,000, 
C $2,000 and D nothing. During the month of December, the receipts of 
A were $4,000, of B $5,000, of C nothing, and of D $13,000. The total 
receipts were, therefore, $75,000. The payments for October were: A 
$21,000, C $5,000, and the other two companies nothing. The payments 
for November were A $5,000, B $10,000, C $2,000 and D nothing. The 


41 


payments for December were A $1,000, B $6,000, C nothing and D $11,000. 
The total payments, therefore, were $61,000. The cash on hand was the 
excess of receipts over payments, amounting to $14,000. 

It will be assumed that the foregoing facts have been verified, and 
that it is desired to state them in form convenient for ready understanding 
by one without accounting knowledge. 

It is obvious that the figures must be recast, in order to afford an 
intelligible idea. First of all, following the principles before stated, the 
summary of receipts and payments, with the resulting cash balance, 
should be shown to convey an idea of the transactions as a whole. 

It may seem to the lay mind illogical to present a summary, or 
summing up, before the facts wpon which it is based are presented, but 
it naturally results from an acceptance of the principles stated. The 
summary, like the porch to a house, provides the entrance, but it is the 
last to be constructed. The summary results from a recapitulation and 
condensation of the various schedules and statements. There is nothing 
to prevent a reference to the summary after a consideration of the details, 
in case it is needed for a review of the situation. 

In the attempt to analyze the receipts in the case given, it is found 
that they may be analyzed either by companies or by months. Inasmuch 
as there was not a complete operation of each company for each month, 
and also in view of the fact that comparisons with months of other years 
are not required or possible under the conditions, a statement of receipts 
and payments by companies is the first step in amplifying the summary. 

The next step in the analysis is to show the receipts of each com- 
pany by months. By this method, the mind is gradually carried from 
a condition that is comprehended to statements involving more detail. 
The arrangement is such that one may leave off consideration of the 
statements at the end of any one, with a complete idea to that point. 

The statements, especially arranged to illustrate the application of 
the principle, follow: 


42 


BLANK THEATRICAL COMPANY. 


STATEMENT OF RECEIPTS AND PAYMENTS FOR THREE MONTHS ENDING 
DECEMBER 31, 1902. 


Summary. 
Bee ED Ss As DOT ALLAOUCC sei. ue a eat atta Ce sols ya's $75,000 
MeO UN DS a5 Nel ALLACUOd Lc. se eyed ere ac at ey sie se tie tie 61,000 
Pe enICon CASEY OLIaNty oot Sin gieGnne et etiee ccs etal e tole tees $14,000 


Statement by Compantes. 


RECEIPTS: 
EG eee Ould slau a Ree ea ef eru aa $35,000 
UD acta A) PARDEE NE og leg ts FR RC eR aay 15,000 
1 GLE pleco pia: ani tar ear oO Oe ae nm ar ead 12,000 
EOE ele: AW URE ot ard Bas, eae ins Bap ace I 3,000 
iy Sh are Gah CRT TS Re eee See ge am RRR $75,000 
PAYMENTS: 
oye phe ts Bog 2 RAMEE DUE Los hs ae Poe ee $27,000 
SNE eS ee I te a Neate e hae 16,000 
Oe BOE EAR gle ine CONES Bian rors 7,000 
ree Faherty UN ey Gute sieuh eevee alee fe 11,000 
Pheveo. Pile Serena nn CGR saint ti le Ui pea Siwy oka ava Sande dian Veh an gle « 61,000 


Balance, Cash on hand, as per Summary........ $14,000 


43 


Statement of Companies and Months. 


RECEIPTS: 
om 
OChObaricas ese heen wre k cece $20,000 
Novembercoiine.. oi. SS 11,000 
December veins bete aee 4,000 
a $35,000 
po. 
OCTODEE Sc nce Us he Gee fe) 
November: .......55c50sss5un $10,000 
December... i.. os eee 5,000 
——___— 15,000 
Cee 
October s.:...c ise dole en eeeeoe $10,000 
Novemiber:.: os 0s uu easels 2,000 
December); oss chou verb eee O 
12,000 
pee 
October... 2o. Sate eee fe) 
November :.¢ i eciissees ie eee Oo 
December’. J.Gay <p amen ee $1 3,000 
eo ees 13,000 
Total Receipts. jis fie whe ey ee a , 
PAYMENTS: 
Ao 
OCctOBePrindaxentsssesssut betes $21,000 
November. 2ceer 9. . spin ae ee ee 5,000 
December cee ee ee 1,000 
————— $27,000 
Ras 
OCtG Rete ae! ows os el eee ee fe) 
NOVEIDDGT oir aos 5 Boob te heeeat ee $10,000 
Debemiber f0. 4 3 coe oie Eee eee 6,000 
—————_——_—— 16,000 
Ck 
CIOUGDET: Aika. aa ic ooh ee ee $5,000 
November. =e: eitiee wae bee te 2,000 
DeCendbeT . iio ates se ee oe Oo 
7,000 
pee 
October 4d eek es ee O 
November iii. «sk se sien eee fo) 
Décember\s. 5 luke tie ee $11,000 
— 11,000 
Total Payments «4 \.:<) Ae pera ene Bete a 


Balance, Cash on hand, as per Summary...... 


$75,000 


44 


If the presentation of results by months is desirable, tables may 
be used, in lieu of the statements, that will show the total receipts by 
months, the company receipts by months, the total receipts of each com- 
pany, and the grand total. This affords a display of detail with an econ- 
omy of space, but the detail is not so readily followed as in the former 
statements, and it is not so fortunate an illustration of the principle 
under elucidation. The tables follow: 


RECEIPES: 
Month Total A B OF D 
1902 
EE Ee ee $30,000 $20,000 ° $10,000 ° 
1 tel) de Ra 23,000 II,000 $10,000 2,000 ° 
ONS SS ee ee 22,000 | 4,000 5,000 ° $13,000 
ON a Ee es $75,000 $35,000 $15,000 $12,000 $13,000 
PAYMENTS. 
Month Total A B C D 
1902 
Ty GI RS Sa area $26,000 $21,000 ° $5,000 O 
LO eS) Oe ee 17,000 5,000 $10,000 2,000 fe) 
ME MERAETO ENT «y's. 4 'e2c bid a bh wher ee 0's 18,000 I ,000 6,000 ° $11,000 
AMEE card 4) way ay ile <nmenie tyis $61,000 $27,000 $16,000 $7,000 $11,000 





The principle that produces the economy of space in the foregoing 
tables is the use of each amount under two classifications. Thus, the 
amount $21,000 under A, is opposite October, and means that the pay- 
ments of A in October were $21,000. A summation of both classifications 
is possible, so that company totals, as well as month totals, are available. 
The total of company totals must equal the total of month totals, so that 
this amount, $61,000, supplies a check figure to guard against mistakes. 
Thus, if an amount is omitted from the B column, the company totals 
will not prove against the summation of the month totals. 

The total column, like a summary, is stated first in order to convey 
a complete idea at first glance. The principle involved in the use of such 
a column is used throughout accounting, in books of account, in state- 
ments and in the analyses that form, especially in auditing, a large part 
of the accountant’s work. 


45 


For economy of space it is usual to use the side column for the more 
numerous items. Thus, if a list of customers’ accounts were to be made, 
showing items not due, overdue less than 30 days, overdue from 30 to 
6o days, and overdue more than 60 days, the total column and the four 
classifications would each be given a column, and the names of the accounts 
would be listed to the left. The work would be proved by determining 
that the totals of the distribution columns equaled the total column. 

It should be observed that a proof of this nature proves totals, but 
errors in distribution, by which an amount is placed in the wrong column, 
would not be detected thereby. 

If we consider the statements again, it will be observed that the net 
outcome as to receipts and payments for each month is not shown. It 
could be calculated from the figures given, but if it is likely to be needed, 
the accountant should make the calculations and present the figures. 
It could be done in this way: 





October: 
Receipts 
Payments 
Balance 
November 
Rechints.clas ices Greene $23,000 $11,000 $10,000 $2,000 $ ° 
Payments rsi0 no tee cre 17,000 5,000 10,000 2,000 ° 
Balance. ccen be pare a $6,000 $6 ,o00 $ ° $ ° $ ° 
December 
REGIE 27h bes eee ee $22,000 $4,000 $5,000 $ ° $13,000 
PAyITeN ts ches o\piincte hs bee 18,000 I ,000 6,000 O II,000 
BAlANCe Gets wee $4,000 $3,000 | —$1,000 $ Oo $2,000 
Stan Atal. hia ek owe oe $14,000 $8,000 | —$1r,000 $5,000 $2,000 





The difficulty in the preparation of the foregoing statement is that 
there are three classifications in the table, namely, companies, months 
and classes of transactions (receipts and payments). The last classifica- 
tion was avoided in the preceding statement by making two statements, 
one for receipts and one for payments, as indicated by the respective 
captions. To cover in the one statement the three classifications, the net 
result of each month is obtained, and the totals for the months added for 


46 


the grand total. This is a common expedient, but it might be avoided by 
making an entirely separate statement for each month, and then bringing 
the totals into a separate recapitulatory statement. 

The shortages that occurred in certain months were indicated by a 
minus sign. Thus, in October the payments of A exceeded the receipts 
by $1,000, leaving a shortage so far as that company was concerned. C, 
however, produced an excess of receipts over payments of $5,000. The 
ageregate excess of receipts over payments was $4,000, obtained by sub- 
tracting the payments from receipts in the total column, and proved 
by subtracting the minus $1,000 from the $5,000. If there were no short- 
ages, the proof would be secured by cross adding the company totals. 
Instead of the minus sign, italics or a different colored ink may be used 
to indicate an inverse element, such as a shortage or deficit. 

The Statement of Receipts and Payments could be displayed in the 
form of a Cash Book, receipts to the left or debit side, distributed in 
columns to conform to the companies, with a total column, and a similar 
arrangement for payments on the right or credit side. This is a usual 
form for simple statements. 

The methods of presentation given seem to cover every possible 
requirement, and the circumstances of the case would determine which of 
the statements could be eliminated. The principles of presentation and 
statement construction are of importance owing to their universal appli- 
cation, and the use of receipts and payments is merely an illustration. 


The Form of a Report. 


One of the two prime objects of accounting is the determination, at 
any desired time, of the financial position. This is displayed in one of 
the two basic statements of accounting known as the Balance Sheet. 

The other prime object of accounting is the determination, for any 
elapsed time, of revenue, or profit and loss. This is displayed in the other 
basic statement of accounting, known as the Profit & Loss Account. 
There are various forms of such an account, but a consideration thereof 
is not essential at this point. - 

The statements named form the basis for nearly all reports in account- 
ing and auditing, for it is usually essential to present the financial con- 
dition, together with a showing of results of administration over a period 
of time extending back to a former statement of financial position. 

The simplest report covering both objects is made in the form of a 
Balance Sheet and Profit & Loss Account, with a certificate that they 
correctly state, respectively, financial condition and profit and loss results. 


47 


When there are conditions that call for comment, the statements may be 
accompanied by an explanatory letter or report, discussing the items; 
this report usually precedes the statements proper. Following the prin- 
ciple of presentation, it is desirable to begin the report, in many cases, 
with a summary of conditions. 

While there are two well-defined objects in Accounting, and it is 
usually necessary to present both statements in a report, one is likely to be 
of greater importance than the other. For example, the question of profit 
distribution may be foremost, and the state of assets and liabilities, dis- 
closed by the Balance Sheet, while of importance, may be secondary. 

On the other hand, a banking institution is likely to have but few 
proprietors, or owners, and thousands of depositors. The latter, for whose 
benefit statements are published, are interested primarily in the financial 
condition, that is, the ability of the bank to meet all possible demands 
upon its assets, and not in profits. Hence, the Balance Sheet, or State- 
ment of Assets & Liabilities, as it is often called by such institutions, 
is of first importance. 

In the event that the income is of primary importance, a summary 
thereof might be presented, thus: 


Gentlemen: 

In accordance with your instructions, I have audited the accounts 
of the Blank Company for the year ending December 31, 1902, and find 
the outcome as to Profit & Loss, in summary form, to be as follows: 


Net. Sales isis escs aces css i oaruge ee cee pase pate a $142,520 
Net Cost of: Sales’) .:..9ipet ets wate ce eee ieee Ying be 

Gross ‘Protititts 8: aii 2.3. is ose kt (RNR eee ee be ee $64,805 
EXPenseS so aateieie oo bh alspe alaceytare’s bye beh eats Oaks ot 41,890 


Net, Proiit, (5 .<. <p ss knees ete oe oe $22,915 


Instead of the condensed revenue statement, in some companies a 
condensed balance sheet may be given if the financial position is of first 
importance, or both may be given. 

Following the condensed statement, which supplies the general thought 
or idea as to the vital facts, the comment in the body will amplify and 
deal with the items in the summary first given. In the case of a Revenue 
or Profit & Loss Account, it may deal with the items of expense by refer- 
ring to the amplified statements appended, and giving reasons for increases 
or decreases. This is the more readily done if such supporting state- 


48 


ments are made in comparative form, similar items being compared for 
two or more years. Thus a to per cent. increase in wages, or increased 
volume of business, or both, would account for a certain increase in wages, 
and a miners’ strike might account for increased cost of coal. 

The items in a Balance Sheet might be dealt with in the order of 
headings. Thus, a fire insurance adjustment and rebuilding would justify 
special comment upon Plant & Machinery. In this way, no item calling 
for special note would be overlooked. 

The order, then, as far as stated, would be: 

1. Condensed, or summary, statement, usually of Revenue. 

2. Comment thereon with reference to attached Profit & Loss Account, 
which in turn may be supported by schedules of detail. 

3. Comment upon Balance Sheet items, which may be supported by 
schedules. 

4. Miscellaneous comment and recommendations with reference to any 
special statements. 

5. Balance Sheet, with supporting schedules. 

6. Profit & Loss Account, with supporting schedules. 

7. special statements. 

The order may be varied to suit conditions, but the report is best 
prepared along the lines of presentation, by summaries, of complete ideas, 
supported by articulating statements expanding in detail, but leaving, 
at the termination of each, a finished or completed idea. 





fas 
ih th 


Le 


a 








INTERMEDIATE THEORY AND PRACTICE 
OF ACCOUNTS. 


| By HOMER ST. CLAIR PACE, C. P. A. (N. Y-) 
EECLORE 1. 


CONSTRUCTIVE ACCOUNTING. 


PME EN RNG ec A ie ee he Ge dip oe Cavie ee dv wie sez UI TON Aap ee ga vole or i 
Weve rR ACCOUNT CEASSIFIGATIONG 2 o¢ ere oc AA oy I 
Uorumasn Ltocer DEVELOPMENT. 65.9). 40) ee a 
ADVANTAGES OF COLUMNAR LEDGER ACCOUNTS.......... aera ae 

- CLASSIFICATION IN Books OF ORIGINAL ENTRY... .....0 00000 cscs. Oey 

CLASSIFICATION IN CAsH RECORDS jy oan. % PT eee er aves Le Ty 8 
VoucHER REcoRD CLASSIFICATION Bt Fane San Che Miran ANNIE Maa ge 


ty Review. bee ORES, WMI Ligh Ue aha ped SS Pupeet ake, Reyna CY hal iota 12 


COPYRIGHT, 1013, BY 
‘ Homer St, CLAIR Pacg, 


Sp ony aie 
nfs 





INTERMEDIATE THEORY AND PRACTICE OF 
ACCOUNTS. 


By HOMER ST. CLAIR PACE,C. P. A. (N. Y.) 
LEGLURET: 
CONSTRUCTIVE ACCOUNTING. 


In General. 


Accounting may be defined, broadly, as a record of financial trans- 
actions. In its developed state, narrowing the definition to a commercial 
enterprise in which accounts are kept by double entry, it provides for 
an initial record of assets and liabilities and the resultant investment, 
and for all changes subsequently occurring therein. 

The record must include the transactions in the property rights and 
values that are employed in the particular enterprise. 

The record must also include the transactions with each individual, 
either debtor or creditor, with whom the enterprise has business relations. 

The record must also provide, under the double entry method, for 
nominal, or statistical, elements, by which the sources of increased values, 
and the expenses or losses, measuring a past or future reduction of asset 
values, are shown. 

The value of the accounting record will depend, to a considerable 
extent, upon the classification of facts in regard to each subject of interest. 

The primary classification is into debits and credits in respect to 
property, persons or subjects, and is effected by journalizing, in one form 
or another, the principles and practice of which have already been suf- 
ficiently considered. 


Ledger Account Classification. 


The journalizing may provide for but one general property account, 
to be raised in the Ledger, to which all debits and credits arising out 
of property transactions would be carried. Under such a procedure, in- 


Copyright, 1913, by Homer St. Clair Pace. 


2 


formation in regard to a specific piece of property would be obtained by 
an analysis of the original record, in which the details would be recorded. 

The natural development from this point consists in the creation of 
additional ledger accounts for property, to each of which are carried the 
debits and credits pertaining to a specific piece or class of property. 

Thus, a general account might be provided for real estate, or an 
account might be created for each distinct parcel of real estate. If all 
debits and credits arising out of real estate transactions were carried to 
such a general real estate account, a continuing classification of real 
estate property, as distinguished from other property, would be made, 
and the net book value thereof would appear as a debit balance in the 
ledger account and in the statements prepared therefrom. If accounts 
were raised for each tract or parcel, then the classification would be car- 
ried still further, and the debit balances of the accounts would show the 
value of the respective parcels. 

In the same manner, the other items of property might be classified 
in the original record and made available through ledger accounts, the 
divisions and captions depending largely upon judgment. In practice, 
the classification of property into accounts follows such general lines of 
subjects as may, in the particular business, afford ready information as 
to the state of any class or piece of property, with the minimum of effort 
in making the bookkeeping record. 

So far as the transactions with persons, debtors and creditors, are 
concerned, the natural and ordinary classification is to provide an account 
for each individual, to which are carried all the debits and credits re- 
sulting from the transactions with such person. The net result, or bal- 
ance, of each account will disclose the net asset or liability, as the case 
may be. The attempt, sometimes made in the case of small concerns, 
to run one general, or summary, account for accounts payable, unsup- 
ported by vouchers, does not often give good results. 

In recording nominal elements, by which statistics as to the increases 
and decreases, known as profits and losses, are recorded, the simplest 
method would be to provide a general income, or profit, account, to dis- 
close gross gain, and a general expense account, to disclose the costs or 
expenses that are an offset thereto. 

In response to the demand for knowledge of causes, essential to 
successful management, an analysis of the expense elements is made 
into classes of costs, continuing throughout the accounting period. For 
example, the cost of salaries, wages, insurance and rent, might each be 
collected in a distinct account, a general expense account being maintained 
only for such costs as would not classify under one of the stated divisions. 


3 


The income or profit may also be classified, if it arises from differ- 
ent classes of transactions. In such a case, the direct charges to each 
class may be held in distinct expense accounts, and the general charges 
distributed on some equitable basis, so that the net result as to profit 
and loss can be determined as to each class of transactions. This is the 
basis for departmental accounts, by which the trading or operating result 
of each department is ascertained. 

The limitation upon the classification of property transactions and 
nominal elements by ledger accounts is of a bookkeeping nature. In 
practice, such classification is found desirable in the accounts of the 
smaller traders and manufacturers. When the number of the accounts 
becomes too great for convenience in bookkeeping, the classification can 
be secured with less labor by other means, as will be explained. 


Columnar Ledger Development. 


The creation of the numerous ledger accounts necessary to a minute 
classification burdens the Ledger, and renders necessary the handling of a 
large number of accounts in the trial balance. In addition, while it gives 
a classification of the transactions affecting a particular thing or subject 
from its nature it prevents a view of the transactions as a whole. Besides 
having the expenses divided into five distinct classes, it may also be de- 
sirable to have available in one place the entire amount of expenses, with 
the relation of each class to the other classes shown. 

To relieve from the labor of handling additional ledger accounts, and 
to secure the advantages of a total record and the association of the con- 
stituent elements, resort is had to the columnar development of the ledger 
account. 

Thus, one ledger account could be opened for Expense, ruled with 
the ordinary columns for date, folio, and debit and credit amounts, but 
with additional columns on each side for the five classes of expenses neces- 
sary in the particular undertaking. In making the entry in the book 
of original entry, the classification to which it belonged would be noted, 
for example, Salaries, and the amount would be posted in the ordinary 
debit column, and the amount would also be placed in the classification 
column for Salaries. 

The foregoing process continued would give for any desired period 
an account that would disclose the total charges to Expense, together 
with an analysis of the various constituent elements. The proof of the 
entry of the items in the distribution columns would be secured by the 
summation of such distribution columns and the determination that 
the aggregate thereof was the same as that of the total column. 


4 


Any credits arising could be carried to the credit side and distributed 
in distribution columns provided therein in the same manner, although 
in the case of expenses, such credits are apt to be rare, and in order to 
save ledger space, they are often indicated by red ink entries on the debit 
side, or are subtracted and the balance carried down, thus avoiding en- 
tirely the usual credit side of the account. 

Such an Expense Account might include all the nominal elements 
of expense or cost, or it might include and classify only those that are 
commonly charged to a so-called Expense Account. 

The debit ruling of such a ledger account, showing the total and 
distribution columns, is as follows: 


Date Explanation | F | Salaries | Rent | Freight | Cartage | General} Total 


—————— |_| | eee | 5 | 


Instead of providing a credit page with the full ruling as shown above 
or making the red ink entries or deductions in the above ruling, a credit 
column could be provided adjacent to the debit column. Credit entries 
could then be entered in the classification columns in red and, in proving, 
the work, the total of such red ink entries in a column could be deducted 
from the total of the black ink entries. The summation of the results 
of the distribution columns should then prove with the balance of the 
regular debit and credit columns. 

In the same manner, a property account may be developed, and 
an analysis of transactions made by the columnar method. Thus, a 
real estate account may be analyzed as to land, buildings, betterments 
(not repairs), etc. The credits are likely to be more numerous in prop- 


~ 


) 


erty accounts than in nominal accounts, so that a complete duplicate 
ruling for the credits is often necessary. 

Sales or earnings may be classified by a columnar ledger account, 
instead of maintaining a distinct account for each class. Thus, in the 
case of a company supplying gas to private consumers and to a city, the 
gas sales could be displayed in this way: 


Private Municipal 
Deduc- Consumers 
tions Date Details eA > __ | — | Total 
(Dr.) (Cr) 
Regular| Prepay- | Streets | Buildings 
ment 


a 





The deductions (allowances) on account of bills and sales are com- 
paratively infrequent and are entered in one debit column. This would 
have to be analyzed periodically and the deductions made from the re- 
spective columns. Or, in the case of numerous deductions a debit column 
could be provided for each class of sales, either at the extreme left, or 
the debit and credit columns for each classification could be adjacent, 
with the total debit and credit columns to the extreme right. 

It is not intended to consider fully gas accounts at this time, but 
merely to illustrate the principle of ledger account development. 


Advantages of Columnar Ledger Accounts. 


Columnar development of ledger accounts, so far as classification 
of transactions is concerned, has many uses, although like many other 
expedients in accounting, it is not desirable in all cases. 

In the accounts of small undertakings, with the total number of 
accounts within reasonable limits, there is little use for it. 

In case a compiled analytic statement of certain phases of the busi- 
ness is often needed, the columnar ledger account offers a ready and 
reliable means of meeting the condition. Columnar classification, as 
compared to classification by separate ledger accounts, requires addi- 


6 


tional work at the time of posting, because the usual debit is made, as 
well as an entry in one or more distribution columns. It should be borne 
in mind, however, that there is compensation in that it is necessary to 
turn up but one account, instead of several; that the distribution into 
columns and the proof thereof safeguard, to some extent, against error; 
that there are fewer accounts to handle in the trial balance; and that 
an analytic statement of the subject is available at all times. 

There may be columnar development of the ledger account of a some- 
what different nature. Thus, in addition to the usual debit and credit 
columns, a third may be provided, into which is carried the balance of 
the account after each entry, so that the net state of the account appears, 
In such a case, it is usual to place the debit, credit and balance columns 
at the extreme right, in the order stated. This ruling is sometimes used 
in customers’ accounts, and in other cases, as will be shown later. 

The Ledger, however, in a broad sense, is but a classification of the 
accounting record, and all devices that are employed therein are useful 
only to the extent that they make available the facts essential to an in- 
telligent understanding and management of the affairs of the concern. 


Classification in Books of Original Entry. 


The classification secured by the columnar ledger, while useful in 
many cases, requires, when it merely supplements and analyzes the record 
made in the books of original entry, practically a duplication of the labor 
required in such original entry work. It is true that the columnar ledger 
may, in certain cases, be used profitably as a book of original entry and 
ledger combined. At the moment, however, the use of the columnar 
ledger as an adjunct to customary books of original entry, is in mind, the 
defect of which, for undertakings of considerable size, is that the results 
are secured without proper economy of effort. 

It is obvious that the most economical procedure, if practicable, 
would be to arrange the original record in such a way that each fact could 
be placed under its proper classification upon its original entry. This, if 
completely carried out, would do away with the idea of a distinct Journal 
and Ledger record. In practice, this rarely happens, for there is a cer- 
tain value in maintaining the distinction, as will more fully appear, but 
for the purpose of illustrating the fact that such a record is possible, and 
in some cases practicable, the case of a combined Journal and Ledger 
for household accounts may be cited. The ruling is as follows: 


‘uor}eoytsse]o Aressooou oyy ATddns ‘jfosqt ut ‘Aeur p1ooor [eUIBIIO oy} JY} JOR} OY} Jo VOTyeIISNIT Ue se [nJosn 
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-daaxpfooq oy} ft pue ‘oun, ev ye yIOM plnoo uossod ouo ATUO yoryM uO proser o[durts wv st JI ‘“UOL}BOYISSe[D VATSUD}X 9 
JO poo OU ST o10Y} PUB MOF OB SUOIPORSUIT OY} YOIYM Ul S}UNODDe 0} POU] st SutoSer1oy oy} Jo osn oY], 
‘ULIOF SuLUUNI ATeUIPIO oY UL JO Pea}SUT 4YYSII 0} 39] 
Woy posure suotydes Jospa] YIM ‘OoULTe [II JO WIIO} & JOS} St pr0d01 oY YSnoyyye ‘out, Aue ye Udyxe} 9q P[Noo 
souvled [e} Y “yunoooy [eydey 0} paLojsuvsy 0q Udy} P[noo owOoUT UMVIPUN OYJ, “JUNODDY sUTOOUT 0} s}UNODIe 
esuddxo oY} WOT} JOONp ope oq P[Noo si1ojsuvs} Aressooou 9y} “IQ “BUISOTD Jo ou, oy} 72 YULTG Joey, UUINjOD oy} UI 
JUNOIOWY SSO’T 29 JOLd & UL PopoTJOO Oq PTO sol1jUs [eUIMION “SUTSO[D JO 9UIT} oy} [JUN o8ed 0} o8ed WO, preMIO] 
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pue qiqep 0} sev UOrOUl{sIp Onp YPM porlojJUe o1B SUOTJOVsUeIy JUONbesqng ‘soUR[eq [[IM YOIyA Jo sytpeio pue syqep 
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8 


Classification in Cash Records. 


In the simple household accounts heretofore considered, it was shown 
that a classification, inclusive of all transactions, could be made in a 
single record. It would cover Journal, Cash Book, and Ledger functions, 
with all necessary display of essential facts, on a single page. 

In large undertakings this would be impracticable, owing to the 
number of transactions and the desirability of a more minute classifi- 
cation. The original record in larger enterprises is likely. to provide for 
the grouping of related transactions, such as cash receipts and payments, 
sales, purchases, etc., and the attempt at classification is directed to 
one or more of such records. 

The Cash Book affords a conspicuous example of the grouping of 
similar transactions, and it is often developed by columnar classification. 
As has already been shown, the Cash Book is, in principle, a Ledger ac- 
count in which direct entry of cash receipts and payments is made. A 
saving of effort is effected through the addition of columns to hold items 
to be posted in totals periodically. 

In a simple form of Cash Book, this development extends to the 
use of a column for items of expense, on the credit side, and for cash sales, 
on the debit side, with additional columns for discounts if such associated 
items are recorded in the Cash Book. The columns provided usually 
cover the greater number of transactions, but they effect only a few 
Ledger accounts. Many postings will be made, however, from the general 
column, affecting a large number of ledger accounts. 

The fuller application of the columnar principle to the credit side of 
the Cash Book would provide for a classification of all transactions asso- 
ciated with money payments. It would include all costs or expenses, and 
all property, paid for in cash. 

The success of the Cash Book distribution depends upon the main- 
tenance of a cash basis, or a condition that approaches closely thereto. 
Otherwise, liabilities would be incurred on account of costs and property, 
and the entry and distribution of the latter would be postponed until 
cash settlements were made. Entry and distribution could, of course 
be made in the Journal, which could also be used to carry in unsettled 
and accrued items at the time of closing the books. 

On the debit side of the Cash Book, the receipts, if from cash sales 
or returns, could be distributed under suitable captions, but the entry 
of sales or returns that pass through accounts recording transactions 
with customers could not be postponed until date of settlement, because 
the state of the specific account could not, in the meantime, be ascer- 
tained from the books. 


9 


It is obvious that the Cash Book classification is dependent upon 
the flow of cash in and out, a matter that is not in many cases imme- 
diately associated with the acquisition of assets and the incurrence of 
costs, and which, therefore is not well adapted to the control of the 
accounting record. 

The nearer the business approaches a cash basis, the more satis- 
factory such a distribution will be, and there are many cases in which 
the method produces satisfactory accounting results. Its use is largely 
confined to small water, gas and electric light companies, where collec- 
tions and payments are upon practically a cash basis, to the accounts 
of fire insurance companies which approach a cash basis, and to the con- 
ditions found in clubs, associations and other undertakings where the 
state of affairs is substantially as outlined. 

In the form of. record devised for household accounts, no separate 
ledger is needed, for the record, complete in itself, serves every ledger 
function. When the record is divided, however, the various parts must 
be brought together to provide a view of the accounts as a whole and to 
give the characteristic double-entry proof of accuracy. Therefore, the 
ledger resumes its place as an essential record, and the classification, as 
made in the separate parts of the original record, is carried to the ledger, 
either in an account for each classification, or to a summary or controlling 
account that controls several such classifications. 

It may be accepted as a principle, that the Ledger is a necessary 
record in systems of modern columnar books in which classification 1s 
largely made in the books of original entry. It is necessary to establish 
the periodical proof of the double-entry accuracy of the records, and to 
afford a view of the accounts as a whole. 

For the purpose of illustrating the principles that have been pre- 
sented, the credit side of a Cash Book, ruled to show total cash payments, 
distribution into three property accounts, five expense accounts, and a 
miscellaneous column for items not coming within the distribution col- 
umns, is given as under: 


H 
Oo 3 
G ed ° 
n va q a 
5 P| 3% ee ete Ad he oC 
4) n}|%&}m |g] s = 
olf a laRl slew lead ol hl al 81 8) ype 
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ONES Fie l El eg) eye voen ee 
a BSHaAaTM |e |] a] & m | a | i eee 























} Property Expense 
Details 


A A ledger account co account could be |) WA Jedger account could bemaised #or,eachisib iene ast tan lian for each subject in the record, and 
a posting made thereto at the stated time, usually at the end of a month. 
In highly developed books of this kind, a ledger account is provided only 
for the total of each general division. Thus, in the use of the ruling given, » 
an account would be raised for Property, and one for Expense, and a 
posting would be made at the month-end for the total in each case. The 
original record is thus brought into the ledger in summary form, and 
reference is made to the Cash Book for more detailed information. 

The classification can be recapitulated, for convenience, by months 
and years, either on a page reserved for that purpose, or in a special book. 
This can be done in the same ruling as is provided in the Cash Book, or 
separate rulings may be made. A special ruling, covering the item of 
Expense, is as follows: 


MONTHLY EXPENSE* RECAPITULATION, 1002. 


Salaries | Supplies | Salesmen | General 





October 





Il 


The total of each classification would be entered from the Cash Book 
at the end of each month, and the record would serve much the same 
purpose as a columnar ledger account; in fact, it could be used as a 
ledger account and the summary ledger account omitted. 

A similar recapitulation could be made for Property and for any 
other subject. A yearly statement could be made for a series of years 
by using the yearly, instead of the monthly, totals. 

Simple rulings and examples have been chosen to illustrate the prin- 
ciples. In practice, recapitulatory statements are common and, in many 
cases, exceedingly useful. 


Voucher Record Classification. 


The principles of the Voucher Record have heretofore been stated, and 
it is here intended merely to study it from the classification viewpoint. 

The Voucher Record is a book of original entry, designed to classify 
items of property and costs, and to provide, by a summary credit posting, 
_for an account controlling the liabilities on account of such items. The 
distributions are posted as debits to ledger accounts. 

Entry in such record is dependent only upon the acquisition or in- 
currence of the item, and it is therefore not subject to the uncertain flow 
of the asset cash. For this reason, it is suitable for use in undertakings, 
irrespective of whether or not they are on a cash basis. 

It will be recalled that the detail of the transactions with the cred- 
itor is recorded in a document known as a voucher. Unpaid Vouchers 
account, the summary account with creditors, is charged from the Cash 
Book. When the Voucher Record covers all items for which settlements 
must be made, no entry need be made on the credit side of the Cash Book 
except to Unpaid Vouchers, which simplifies that part of the Cash Book 
and renders all classification columns unnecessary. 

A Voucher Record, however, covers only purchases, that is, items of 
property and costs, so that sales or income must be entered in other records. 
This may be done in classified columns on the debit side of the Cash Book, 
or in classified sales records, or in both, depending upon whether the 
business is transacted upon a cash basis, a credit basis, or both. The 
Voucher Record, therefore, supplants only purchase records and credit 
classifications in the Cash Book. 

The distribution columns for debit postings may be increased in 
number in order to make any desired classificatidn. In case the postings 
become too numerous for convenience, groupings may be made and the 
totals posted to a summary account, as was suggested in the case of the 
Cash Book. 


i2 


In case the divisions are so numerous that they cannot be conveniently 
handled in one book, the Voucher Record proper can be reduced to a few 
summary classifications, as, for example, Property, Operating Expenses, 
etc., and the voucher totals entered therein. The distribution can then 
be made in subsidiary analytic records from the details provided on the 
voucher. Thus, the subsidiary analytic Expense record might be pro- 
vided with twenty classifications, into which the items would be dis- 
tributed from the Expense vouchers. The total of such distributions 
would then be proved against the Expense column in the Voucher Record. 
This method provides for the convenient handling of the work with com- 
plete analysis. 

The specific devices are innumerable, but they rest upon the few 
principles stated. A book of original entry may expand by the addition 
of columns until its size renders it cumbersome. It is then reduced by . 
the treatment of subjects in summary form, supported by subsidiary 
analytic books. 

The classification that is secured in Bills Receivable and Bills Pay- 
able records, and in Sales Books, has been sufficiently considered in pre- 
vious lectures. The field of possible classification, therefore, so far as 
principles are concerned, has been covered. 


In Review. 


A review and summarization of the lecture will be undertaken to 
insure a grasp of the principles involved. 

The object of classification is to make available the information, in 
respect to transactions, that is essential to management. The subject 
has been developed by certain well defined stages, viz.: 

1. The primary distinction is as to debits and credits, applied for 
convenience to three distinct subjects or divisions, as under: 

(a) Transactions with property; 
(b) Transactions with persons; 
(c) Statistical or nominal elements, that result from (a) and (b). 

2. The further classification necessary in each of the groups (a), 
(b) and (c) is secured by providing, for such items as may seem advisable, 
additional ledger accounts. 

3. The number of Ledger accounts, when burdensome, is reduced to 
general groupings, and the classification necessary under each is. secured 
by a columnar display in the Ledger account. 

4. The classification may be made in books of original entry. The 
Cash Book, which is fully considered, is a notable example, and furnishes 
the basis for certain undertakings. 


=o 


5. The classification in books of original entry, when conditions 
are not favorable to a distribution based upon the receipts and payments 
of cash, is best made in the Voucher Record and correlated books and 
distribution records. 


The accounting devices that are incidental to each stage of develop- 
ment may be profitably applied to innumerable sets of transactions. 
Thus, under the second grouping, will be included the accounting of the 
great number of concerns whose transactions do not require a system 
more elaborate than a Journal, Cash Book, and Ledger. It would be 
wasteful to apply the expedients of an analysis-supported Voucher Record 
to such a case. 

The most suitable system is the one that, all things considered, se- 
cures the legitimate objects of accounting in the particular case, with the 
least effort. The accountant, therefore, should have the scope of possible 
development well in mind, know the limitations of the different bases, 
and plan his constructive work accordingly. 

The rulings herein given are not particularly useful or valuable 
except to the extent that they make clear the principles of constructive 
accounting. Attention should rather be paid to the latter, for they con- 
trol innumerable states of fact, and once thoroughly grasped, may be 
applied with comparative ease. 





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ie INTERMEDIATE THEORY AND PRACTICE 
OF ACCOUNTS. 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
LECTURE IL. 


—_—~—-- 


CONSTRUCTIVE ACCOUNTING. 


USACE 6 OTR CE aig ao seag ELCs as ean Nise a Trew TEaea ter ah ame Seb enT e gc 15 
PPO ePROACCOUNT RULINGS (i a Ah aun at Meee a RE Vo 15 
Boston, OR TABULAR, LEDGER...... Dee CS Vi ur a Fy oy 17 
: DEPostrors’“LEnGer’..). serene Big gee HON aM ne es AU ew eleteer ct ge 19 
~ TABULAR LEDGER FOR dh BRIOMCAL OH ARGHS ia iity or ahecsiain Ripe oie an 21 
Se MIOMSTRNOT VE VP RINGIPLES: 6 gts uc bok Vig Ce he hac Uk wee tales 23 


Pe oen Lae AN CARD DEVICHS oul ee er ee ow ote ele rea 24 


COPYRIGHT, 1913, BY 
HoMER St. CLAIR PACE. 


Nd Mounts 
ni 


*< yeh if 


4) 


Se hcraees 





INTERMEDIATE THEORY AND PRACTICE 
OF ACCOUNTS. 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


ERECT URES LE 
CONSTRUCTIVE ACCOUNTING. 


In General. 


The need for classification is present throughout all accounting, and 
there are innumerable rulings and devices by which it is accomplished. 
In the previous Lecture, the subject of classification was treated in its 
fundamental aspects, and rulings and forms were given to illustrate the 
principles presented. 

A further consideration will now be undertaken, dealing with still 
other practical rulings and devices. The student, in this way, will obtain 
a working knowledge of many of the expedients common to different 
phases of accounting. 


Ledger Account Rulings. 


_ The prime essential in the ruling of a Ledger account is that there 
shall be a debit and a credit money column, or at least that there shall 
be provision for making the distinction between debit and credit items, 
which, in their nature, are opposed to each other. 

A common departure from the standard ledger ruling is the sub- 
stitution of a Journal ruling, in which the debit and credit money columns 
are placed in apposition at the right. This form is often used for customers’ 
accounts, where the debits are likely to exceed greatly in number the 
credits, and where the balance of the account is a matter of frequent 
interest. The ruling results in a saving of the major part of the space 
that is allowed for explanations on the credit side. On account of this 
saving, two, or even three, accounts may be placed in the width of a 
Ledger page. The ruling is as follows: 


Copyright, 1913, by Homer St. Clair Pace. 


16 


JOURNAL-RULED LEDGER ACCOUNT 


Explanation 





As a variation of this ruling, a third column, to contain the balance 
of the account, may be placed to the extreme right. This is used for 
customers’ accounts, and it is also used in the ruling of a stock, or shares, 
ledger in a corporation in order that the total number of shares belonging 
to a stockholder may be shown at all times; and, in general, it is useful 
where it is desirable or necessary to show regularly the balance of the 
account. The following ruling is given in illustration of the Journal- 
ruled Ledger account with a balance column added: 


JOURNAL-RULED LEDGER ACCOUNT, WITH BALANCE COLUMN 


Explanation : ; Balance 





A condition might arise where it would be desirable to have the 
debit and credit columns in juxtaposition, while preserving the usual 
amount of space for explanations in regard to both debit and credit items. 

To meet this condition, the following ruling is often used: 


i] 


SPECIAL RULED LEDGER ACCOUNT 








Explanation Explanation 


— | ——_ |{ ——— | | —_———— |  — — _ [ _ 





The foregoing ruling is well adapted for the display of statistical 
information. The money columns are contiguous, as in the Journal- 
ruled form, but the usual explanation columns are maintained, so that 
the detail in regard to the money entries may be entered and classified. 
In the Journal-ruled account, the explanations for both debit and credit 
entries are entered in one column. In case the detail consists of quan- 
tities of articles, such as stores or shares, the intermingling prevents their 
summation. 

The last ruling may advantageously be used for loans secured by 
collateral, as the collateral may be shown as it is received and surrendered. 
In material or stores accounts, too, it may be desirable to keep a record 
of quantities as well as of values, and this can be done in the space pro- 
vided for explanations. Other rulings may be used for this purpose, 
but the one given answers well under conditions in which there is an 
advantage in having the money columns in apposition and space for 
detail classified between debit and credit. There might be cases in which 
there would be an advantage in having the statistical, rather than the 
money columns contiguous, and the ruling could be modified to meet the 
conditions. 

A variation of the foregoing ruling is the addition of a balance column, 
which may be placed between the debit and the credit columns, at the 
center of the ruling. 


Boston, or Tabular Ledger. 


The so-called Boston, or Tabular, ledger is a development of the 
Journal-ruled account that has been shown. The important accounting 
feature in each is that provision is made for the regular presentation of 


18 


the balance of the account, usually, but not always, in a column provided 
for that purpose. 

The tabular ledger, however, arranges the accounts in statement 
form, with the caption of the accounts to the left and a series of distinct 
rulings to the right. One complete ruling, with debit and credit columns, 
and perhaps a balance column, is provided for a certain fiscal period, 
which may be a day, a week, a month, a quarter-year, or a year, as is 
needed. These rulings follow one another from left to right across the 
page, opposite the caption or name of the account. 

If there should be no more than one debit and one credit for each 
fiscal period, one line across the page would be enough for an account, 
as is shown by the following: 


1902 January February March 





Client Dr. Cr. | Balance| Dr. Cr. | Balance} Dr. Cr. | Balance 
Jonn Doe. s5 500 200 300 200 300 200 
Richard Roe... 1000 fe) I000 I000 ° 
iT Olais fee ccrs 1500 200 1300 200| 1300 200 


The balance in the second period is determined by deducting from 
the total of the debit and the previous balance, the credit, thus establishing 
the state of the account as a basis for the next period. With certain 
modifications, the foregoing ruling would provide in a professional office 
for the ledger record with clients. 

The state of account, and its relation to the other accounts, is dis- 
closed by an inspection of the book. The summation of the columns 
gives total charges, total credits and total balance, thus establishing an 
effective control of the entire tabular ledger. 

In case the debits and credits were more numerous, as would be 
likely to happen in practice, several lines would be given to each account. 
There is a limit, however, to the vertical space that can be thus given, 
because the tabular form is dependent upon associating a number of 
accounts on a page. Otherwise, assuming that an account took a whole 


ak] 


page, there would be nothing secured beyond that which is available in 
an ordinary ledger account, with the balance of the account brought down 
periodically. In order to secure proof by totals, the balances would have 
to be abstracted the same as for a trial balance. 

The practical limit is a maximum of six or eight separate entries, 
during the business period, although if a summary were made elsewhere, 
the result of numerous transactions could be entered in the tabular ledger. 
Thus, twenty charges made in a month might be made and summarized 
in another record, and the total entered in the tabular ledger as one 
amount, and a similar procedure could be used in respect to credits. 


Depositor’s Ledger. 


A typical application of the tabular method is found in the treat- 
ment of accounts with depositors in bank accounting. The balance of 
the account is of vital importance. It establishes a basis for credit, its 
amount must be known to make certifications of checks, and it must 
never be overdrawn, that is, a debit balance is not permissible. There- 
fore, it is necessary to require by the accounting procedure that the bal- 
ance be determined and displayed for the smallest possible fiscal period, 
that is, for each business day. 

In bank accounting, too, owing to the fact that money, the quickest 
and most convertible of all assets, is handled in large quantities, there 
is a need for daily proof of the accuracy of the accounting record. The 
tabular form, which approximates a continuing statement, supplies such 
internal check with the minimum of effort. 

The form that was originally used, and that is still used by many 
banking institutions, is as follows: 


20 


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other possible credit, such as interest. The total of checks paid, checks 
certified and collection charges, are entered as a debit from the original 
records, and the excess of the credit column is the amount to be carried 
forward as a credit to the next day. The balance standing to the credit 
of depositors being known as at the close of the preceding day’s business 
can be proved against the general ledger controlling account. The ruling 


is as follows: 
Boston LEDGER, SKELETON RULING 


_ Depositors’ Ledger 
Date Date Date 


Dr. Cr, er Ce Dr Cr: 


WOuu Jones. .... 


Harry Loomis... 


1G, Etc, 

The ruling, in bank accounting, is subject to many modifications, 
depending upon the volume of business and the amount of internal check 
that is considered necessary. The forms given are illustrative, although 
they are both common in practice. 

The use of the tabular ruling for depositors’ accounts is made practic- 
able by the summation of items deposited, and of charge items, in the 
original records, and the entry of the totals only in the ledger. 


Tabular Ledger for Periodical Charges. 

The business period for which the ruling is made may be short or 
long, as the case may require. Illustrations have been given of the use 
of the ruling for daily rests and monthly rests, and one for a longer period 
will now be given. 

In many undertakings, notably those supplying water, gas and elec- 
tricity, charges, payable in cash, are made at regular intervals to cus- 
tomers or consumers. In such cases the amounts are practically all paid 
shortly after the charge is made. This is often brought about by the 
grant of a rebate for prompt payment or the imposition of a penalty for 
delay. For charges thus made and paid, the tabular ledger becomes a 
mere register, showing offsetting debits and credits. The unpaid items 
constitute the accounts receivable, and are comparatively few in number 

Especially in water companies, where charges may not be made more 
often than quarterly or half-yearly, the ruling is in common use, and is 
known as a Consumers’ Register. To show its operation the following 
ruling is given: 


22 


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23 


upon inspectors’ reports, and may, in some instances, be based upon 
meter readings. The date of payment is stamped, or written, in the 
column provided for that purpose, and indicates settlement. Provision 
is made for allowances by a special column. The balance due, deter- 
mined by deducting from the summation of balance due at beginning 
of period and all charges, the total payments and allowances, is carried 
in detail to the balance due column in the succeeding ruling. | 

The use of the totals of the columns will be readily understood. The 
total charges will be posted to a controlling account for consumers and 
sales or rates credited. The total payments and allowances will be charged 
to Cash and Allowances respectively, and the Consumers’ Controlling ac- 
count will be credited. The balance of the latter should prove with the 
total of the balance column in the Register at the beginning of the period. 

The ruling is largely illustrative and wou!d be modified in practice 
to suit the specific conditions. 


Constructive Principles. 


The principles governing the display of accounting facts in ledger 
accounts, together with numerous illustrative rulings, have been given 
in this and the preceding lecture. Many more examples might be given, 
but sufficient have been presented, it is hoped, to make clear the salient 
principles, which will now be recapitulated. 

Ledger accounts are created to collect, for convenient reference, facts 
in relation to transactions in property, transactions with individuals, and 
the increases and decreases in accounting capital that result from such 
transactions. Each account, for identification purposes, is given a name 
or caption. 

The prime essential, in the construction of a ledger account, is that 
provision shall be made for a distinction between accounting debits and 
credits, usually first indicated, although not necessarily so, in another 
accounting record. £ 

The rulings may be arranged in the way that will most conveniently 
display the distinction between the debits and credits, the detail necessary 
to their understanding, and the difference, or accounting balance, that 
results from the offsetting of such debits and credits. | 

The debit or credit entry may be a summary, with the detail analyzed 
in columns provided in the account for that purpose, resulting in the 
columnar form of ledger account. 

The accounts may be arranged in statement or tabular form, so that 
a continuing statement, in form convenient for the determination of totals 
and the proof of accuracy, is secured. 


24 


The common ledger ruling is the most satisfactory for the great 
majority of the smaller enterprises. In very large undertakings, the 
ledger, as such, is reduced to but little more than a check upon the double 
entry principle by a few accounts, largely summary or controlling in 
their nature. 

Finally, and most important of all, no form of ruling should be blindly 
accepted, but the conditions existing in the particular case should be 
studied, and the ruling devised and adopted that will insure the proper 
classification with the least effort. 


Loose-Leaf and Card Devices. 


In the consideration of the ruling of the ledger account, no particular 
attention had been paid to the manner in which the accounts should be 
bound or collected for their classification use. In the usual form of ledger, 
which has been assumed, the rulings are printed upon pages, either one 
or more to a page, as the size of the ruling and page and the needs of the 
particular business require, and the pages are bound into permanent book 
form. With such a binding, in case of error or fraud, a page cannot be 
removed from the binding or a page cannot be substituted for another, 
without a mutilation of the book. There is, therefore, a considerable 
safety and satisfaction in having a record that contains the entire classi- 
fication and in which the relation of each account to the others may be 
studied as to transfers, dates, etc., with the knowledge that the entire 
record is in hand. nu 

In the development of the ledger, one book is found inadequate for 
the accounts of a concern with a considerable business, so that the ledger 
is divided, as has been shown elsewhere, into several distinct books. Thus, 
there may be a general ledger, a private ledger, a creditors’ ledger and 
one or more ledgers for the accounts with customers, which may be divided 
alphabetically or geographically. By this division of the accounts into 
different books, records of a convenient size are secured, and a division 
is made that renders possible the employment of several bookkeepers 
in the work. 

Each unit, or separate book, however, is used in its bound form under 
certain mechanical limitations, among which may be mentioned the fol- 
lowing : 

1. The inclusion of accounts that are closed, and, therefore, of rare 
interest. These accounts must be handled continually in referring to 
the accounts that are open and active, thus increasing the bulk to be 
handled and the difficulty of access. 

2. The loss of space incident to the grouping of accounts. It is 


= 


often useful to arrange ledger accounts in alphabetical or other grouping, 
and to insure this blank space sufficient for the maximum probable needs 
of each division must be provided. This will always result in an amount 
of unused ledger space, which must be handled continually and a part 
of which will eventually be lost. 

3. The inability to divide the record. The bound book prevents 
the division of the record in case statements are to be prepared, or lists 
made, or any work performed in which it is desirable to have more than 
one person work upon the material contained in a single book. 

4. The aggregation of work incident to opening a new ledger. The 
transfer of accounts to a new ledger, when a ledger becomes so nearly 
filled as to render its further use impracticable, necessitates a large amount 
of work to be performed within a limited time. 

Further disadvantages in the use of bound books may come to mind, 
although it is believed that, in principle at least, they are covered in the 
foregoing. In a general way, the disadvantages of the bound form lies in 
that it cannot be kept free from inactive records and it cannot be divided 
for the purposes of classification and work. 

The limitations are in the binding, for without it the accounts appear 
upon loose leaves, which, providing that a sheet is given to each account, 
may be sorted and re-sorted into any desired groupings. An account 
may be removed when it is closed, and a sheet is added when a new ac- 
count is opened. In this way all of the disadvantages of the bound vol- 
ume are overcome. 

New difficulties arise, however, chiefly in regard to safeguarding the 
record against accidental loss of a part thereof and fraudulent substitu- 
tions and abstractions. 

Before considering the methods employed to overcome or minimize 
such dangers, attention may be called to the fact that a ledger account is 
not usually an original record, but a mere classification of that which 
is first recorded elsewhere. For this reason, as a general proposition, the 
objections to the loose leaf method have less weight in regard to the ledger 
than to the books of original entry. A new ledger can be constructed 
from books of original entry, but new books of original entry cannot be 
constructed from a ledger. 

The loose-leaf devices fall into two classes, viz., loose-leaves and cards. 
The loose leaves are used in a binder that retains the form of the bound 
book, into which loose leaves may be placed. They are retained by a 
clamp or a lock. In the case of a lock, a key is provided, so that its pos- 
session is a prerequisite to the insertion or abstraction of leaves without 
mutilation. The arrangement is governed by leaves or tags that give an 


26 


alphabetical or other desired grouping. The sheets of paper, in some 
cases, are water-marked and numbered by the manufacturer and this, 
under proper restrictions, constitutes a further safeguard. An example 
of the use of loose-leaf ledgers is furnished by one of the largest industrial 
corporations, which keeps its stock ledgers, showing the ownership of the 
shares into which its capital is divided, on the loose-leaf basis. 

The cards are cut from bristol board or stiff paper in any desired 
shape and size and are kept in trays or boxes. They are bound, if at all, 
by a rod or other device that secures them in their place. They are more 
convenient for sorting and distribution than leaves from a loose-leaf 
ledger and their use is indicated whenever such sorting is frequent. The 
danger of accidental loss of cards is greater than is the case with ledger 
pages although, in well conducted offices, the chance of the loss of cards 
is slight. Card ledgers are used by some savings banks, where the depos- 
itors’ accounts are kept on cards, but such use is not yet general. The 
use of cards is principally confined to statistical records. 

The tabular ledger ruling is not conveniently handled on cards, but 
otherwise any of the ledger rulings can be used with the loose-leaf devices. 
There are many important uses for these expedients to be considered later. 

The attitude of the accountant should be the same as it is toward 
other devices and expedients. He should thoroughly understand the uses 
and limitations of each and in his constructive work select and adopt 
that which, in his judgment, will best serve the interests of his client. 
Just as no one remedy in medicine is a panacea, so no one expedient in 
accounting meets all conditions. Were it otherwise, there could be no 
profession of Accountancy. 








; INTERMEDIATE TH EORY AND Sree ee 


OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


By TOMER. Sie CUAER (PACH SCBA: 


LECTURE IIL. 


CONSTRUCTIVE ACCOUNTING. 


2 

Wr IRS ATG acer in eH sk INU a eG ORV Gu ely vos weighs awe 27 
eas vo CRENTTORS Sse ei es wera 20 
BrANcH. Accounts, 0.0.0.0... Pee Pete Mine. Cie hada tay fanaa Be 33 
Weer ANAT YSIS C0 as en Oe eee aha No aes 


EO ADPAGCOUNT: CLASSIFICATION (ira cee Sew Y aeck Na opin toatl 39 


COPYRIGHT, 1912, BY 
Homer Sr. Cuair Pac. 


pk a tee 


CHS RRL i fi 
bees ALiy. 


} e,. als 





INTERMEDIATE IT HEORY AND PRACTICE 


OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


Eve LG buh yk COL ACL Rano et eC ag C7 Ee 
LECTURE III: 


CONSTRUCTIVE ACCOUNTING. 


In General. 

In the accounts of merchants, engaged either in wholesale or retail 
trade, the greater part of the accounting detail arises from sales and pur- 
chases of merchandise, and the settlements made with customers and 
creditors. 

The basis may be cash or credit, or, most often, a combination of 
the two. Asa general rule, retail merchandising more nearly approaches 
a cash basis than wholesale trading. 

Many devices have been evolved to economize effort in making the 
accounting record of these transactions, some of which will be considered 
in this lecture. 

Recording Sales. 

It is customary for the vendor to render the vendee, or customer, 
an itemized bill of goods sold. The name of the customer, the date, the 
details of goods sold and the charge will appear thereon. The bill, there- 
fore, includes all information that is likely to be required for the pur- 
pose of future reference, and all that would appear in an original record, 
from which, in fact, the bill is often copied. If the same facts are recorded 
in the original record, say a sales book, there would thus be the work of 
twice writing the same facts. 

The principal labor-saving that can be effected in recording sales 
is to avoid one of the processes, by making a duplicate that will save 
one writing. This may be done by means of a carbon paper or by letter 
press copying. The carbon or copy serves as the original accounting 
record, from which the posting of the charge may be made to the cus- 


tomer’s account. In this way, one writing is saved. 
Copyright, 1912, by Homer St. Clair Pace. 


28 


Instead of loose forms, to be made in duplicate or copied, the original 
and duplicate bills may be bound in a book, with perforations that make 
possible the removal of the original bills. The remaining duplicate bills 
become the sales book, from which postings are made. The bills, owing 
to the bound form of the book, are written with a special pen or pencil, 
and the duplicate is secured through the insertion of a carbon sheet. 

A more practical method is the use of unbound bills which are pre- 
pared in duplicate upon the typewriter. The duplicate is in a form con- 
venient for use in a loose-leaf binder, into which all duplicates are placed, 
and which becomes the Sales Book. In this may be seen the operation 
of the loose-leaf principle in the original record, by which great economies 
in effort are secured. 

The chief difficulty that develops in the use of duplicate bills as a 
sales record is that the form of the record prevents proper classification 
on the record itself. Thus, if five different classes of merchandise are sold, 
a subsidiary columnar record is necessary to make the classification. 
This is easily accomplished when sales are recorded in a regular sales 
book by the use of the columns, but the duplicate bills, in the method 
under discussion, are large, and cannot be classified in a manner convenient 
for summation. This is overcome by the use of a subsidiary sales record, 
into which the amounts are posted under any desired classifications. 

The accounts of a concern that produces and trades in certain builders’ 
supplies will illustrate one way in which the sales may be treated. The 
bills are made in duplicate on the typewriter. The original is sent to 
the customer and the duplicate is pasted into a book kept for the pur- 
pose, although a loose-leaf binder would in most cases be preferable. 
From this book the postings are made to the customers’ accounts and the 
amount is carried to a sales register and placed in a total column and in 
its proper distribution column. If the bill covers more than one class 
of merchandise, this is indicated so that the distribution can be made to 
columns, provided in the sales register for the various classes. In this 
concern, the name of the customer and date of bill are also entered in 
sales register, because it is desirable to display the names of the customers 
in a form that will give an idea of who is buying and the classes of goods 
bought by each. The duplicate bills cannot be viewed as a whole in the 
same manner as a compact sales register. In fact, inasmuch as there are 
but two bills on a page in the duplicate bill book, it is difficult to obtain 
therefrom such information. The inclusion of names and dates is not 
always necessary, and if not, a mere columnar analysis of sales will answer, 
and a greater saving of effort is made. 

The sales register affords totals from which, at the end of the month, 


29 


the customers’ controlling account is charged and the various sales ac- 
counts are credited. The customers’ accounts are posted from the dupli- 
cate bills, so that the agreement of the customers’ controlling account 
and the customers’ ledger proves the work. 

In conjunction with the foregoing, a voucher record, in the ordinary 
form, is used, and a cash book, thus completing the system. 

The saving in the method is the use of the carbon copy for a record 
of the detail of goods sold, inasmuch as the name, date and amount are 
entered in a record that is substantially a sales book. The system is 
not given as a model, although in the particular business it works well. 

There are cases in which the original bill is made by the salesman, 
as is the case in many retail establishments. The duplicate serves sub- 
stantially the same purpose as the ordinary duplicate. A posting is made 
to the customer’s account, in case of a credit sale, and the sale is carried 
to the proper classification in a register provided for that purpose. There 
would, in such a case, be a monthly recapitulation of the charges ren- 
dered to the customer, which, in the case of a retail establishment, usually 
contains full detail. 

The principles are capable of much ingenious amplification, to meet 
the needs of the particular enterprise, but they will be found to be sub- 
stantially the same in all trading accounts. 


Payments to Creditors. 


The practice of securing a receipt, release or acknowledgment of 
payment at the time of liquidating a claim, has existed from time imme- 
morial, and in the case of payments in actual money is of great importance. 
Nearly all payments are made in modern commerce by checks that must be 
endorsed by the payee before collection, so that evidence is secured, without 
special effort, of the receipt by the creditor of a certain amount of money. 

Nevertheless, an ordinary paid check is not an entirely satisfactory 
form of receipt, for it does not specify on its face the items it settles, and 
may be applied in the absence of instructions, as the payee elects. It is the 
custom, therefore, to return with the check the bills covered thereby, in order 
that they may be receipted. In many cases, they are attached to a voucher 
heretofore described, and the latter is receipted. In either case, considerable 
effort is required in following up the receipts and vouchers and in filing 
them. So great is this, that it is not uncommon to hear of a concern that 
takes no receipts, a practice that is not usually approved by accountants. 

The obvious remedy, and the one adopted by many firms, is a com- 
bination voucher and check, the use of which is a receipt for the items 
specified on its face. 


30 


The use of varying and clumsy styles of voucher checks led to the 
appointment of joint committees by the American Bankers’ Association, 
The Society of Railway Financial Officers, The Association of Railway 
Accounting Officers, and The American Association of Public Accountants, 
for the purpose of recommending forms that would meet the various 
requirements of the voucher check, with a minimum of undesirable fea- 
tures. For the guidance of students, who will later be engaged in devising 
accounting systems, it has seemed advisable to quote from the report of 
the joint committees as follows: 

‘“A voucher check or a draft voucher is used when it is intended to 
convey more information and detail than a single check. It furnishes 
accurate statements of account coupled to receipts therefor and proof of 
settlement through a bank. 

“Tt should contain nothing that may affect its negotiability. It 
should throw upon the payor bank the responsibility for only the follow- 
ing items: 

“(a) Its genuine and correct signature. 

‘““(b) The ascertaining of the sufficiency of funds to meet it. 

‘“(c) Alterations in the check portion. 

‘“‘(d) Correctness of the endorsement. 

“For many years, bankers, merchants, manufacturers and railroads 
have been burdened with crude and cumbersome forms of voucher checks 
which were devised for the purpose of combining a detailed receipt for 
payment with an order to pay. The vouchers oftentimes have not been 
in negotiable form, have been covered with advertising, have consumed 
much unnecessary time in scrutinizing, have compelled anyone handling 
to unfold and refold and, altogether, have been about as objectionable 
and awkward for the service they pretended to give as can well be im- 
agined.”’ 

In substance, the following resolutions were adopted: 

That the voucher check be made in negotiable form; 

That a voucher check should be in the form of a straight check or 
draft, and endorsement of the payee thereon be accepted as the only 
receipt required; 

That a voucher check should be of the standard check size and in 
the standard draft form, with the number, date, account and signature 
at the right and in the order named, and the name of the payor (Bank or 
Treasurer of Company) in the lower left hand corner, and that where a 
folded voucher is considered necessary by railroad companies, it should 
fold to standard check size, the check or draft to be at the bottom; 

That when a detachable check is used it should be in the standard 
form described above; 


————— 


31 


That the number, the date, the amount and the signature should all 
be in evidence on the right hand side of the check; 

That the paper of the original should be of good quality and that 
the paper of the copy should be of a different color to distinguish it easily 
and the copy may be of inferior quality; 

That no advertising or business cards should be placed upon the 
check form which may tend to confuse or blind the party handling the 
check or cause important details of the check to be obscured. 

The size of the check or draft form should be from 5 inches to 34 
inches wide by 84 inches long, and folded vouchers of whatever size 
should readily fold to the same dimensions and thus adapt themselves 
to all ordinary check files. Checks narrower, wider, or longer than these 
dimensions are objectionable. 

Four of the most useful forms have been selected from the ones 
given, as follows: 


Newry orks Grty eeu mie me Ser Ge rns COG Var a NI Ge Wy es 


American Bankers Bank 
100 Wall Street 
BEM Cycler oe ate nae Che US ON ht Qa xb ula KOHN 
Dollars 


for 


The above form is a common check form, with a single line indicating the distribution of the 
account settled. 


Voucher No.____ New? Y orkusteoue st bat ne oh On Noe 
eee ad _ TREASURER ; 
Chairman Che American Bankers Association 
Committee FIDELITY TRUST COMPANY, TACOMA, WASH. 


Countersigned and Approved 
Pay to the Order of 


Secretary 


Dollars $ 
President, First Vice-President, 
Chairman Executive Council 


ITEMS 


in full payment of Voucher No. 
THE AMERICAN BANKERS ASSOCIATION 


PAYABLE AT 
NATIONAL BANK OF COMMERCE IN NEW YORK FECL Ba hh ESS A ER a 
NEW YORK, N. Y. (23-A Secretary 


The above is an excellent form for single voucher requiring the approval of several officials. In use by the 
American Bankers’ Association. 


32 








FORM VOUCHER 
STATEMENT OF ACCOUNT SERIES NUMBER 
JOHN DOE & CO. DUPLICATE 
999 BEEKMAN STREET 
NEW YORK 
ADVERTISING OR 
DISPLAY MATTER 
asain tiie 7 cst CHECK BELOW TO BE DETACHED BY PAYEE 
CHECK NO. VOUCHER 
NEW YORK SERIES NUMBER 
Pay To THE ORDER OF $ 
DOLLARS 


IN FULL PAYMENT OF ACCOUNT STATED IN VOUCHER OF CORRESPONDING NUMBER, DUPLICATE OF 
WHICH IS RENDERED HRREWITH 


TO THE JOHN DOE & COMPANY 


AMERICAN BANKERS BANK 
NEW YORK By 








The above voucher check is correct in form for the use of any corporation or individual where considerable 
detail is required. It possesses the following advantages: 
Negotiability. 
A complete statement of account and settlement therefor, for the payee. 
A complete copy of such statement and settlement, together with a distribution record, for the drawer. 
4. A simple, yet fully identified, check or order upon the bank which is easily detached from the voucher 
proper. 
Each party to the settlement receives all the information he needs and the whole voucher does admirably 
what it undertakes to do. 
A carbon sheet should be used for tracing the copy; thus an absolute copy is obtained. 


Whe 








CORRECT 
AUTHORIZED AND APPROVED Chicago, Til. pnosuchtbsecsstnnesrneccineastutet ei 
pul ys oun Pay 10 the.order of 2 eee 
7 ORT TT ah ae Address 4-0 Tree ere ene 
AUDITED Biche ete Pe 
TT ome ib. | <a ee eee ce 
Pakage aah toll in settlement of above account. 

Meriter ied EAST AND WEST RAILROAD COMPANY 
TO THE AMERICAN BANKERS BANK (9) 060) ©) ceeds me 

NEW YORK CITY VOID IF DETACHED TREASURER 





The above is a folded form for Railroad use only and where it is impracticable to use a carbon copy. This 
may be modified to a single voucher or a double-folded voucher, according to the amount of information required. 


6% 


Branch Accounts. 


In the conduct of business, particularly that carried on by merchants 
or traders, it is often expedient to provide for branch establishments in 
order that local territory may be covered more effectively and econom- 
ically than can be done from headquarters. Thus, a firm established in 
New York to carry on a wholesale trade in clothing may find it more 
advantageous to transact its business in the central part of the country 
from a local branch established in Chicago. The supplies of merchandise 
may, as is usually the case, be shipped from the warehouse in the home 
city, or they may, in part or in total, be purchased direct by the branch 
office. | 

There are varying degrees of independence in the conduct of a 
branch, depending upon the conditions peculiar to the enterprise. Thus, 
a branch may be merely a center for distributing merchandise, established 
to facilitate prompt deliveries, without the necessity for accounts other 
than such as would be necessary to keep a satisfactory record of stock. 
The selling would be carried on through salesmen employed and directed 
from the head office, which would determine the credits to be given cus- 
tomers, and make all collections. 

The work of the branch may extend to the selling of goods and the 
collection of accounts, with or without the privilege of purchasing goods 
other than those supplied by headquarters, without an attempt to deter- 
mine profit and loss outcome of the branch. In such a case, there would 
be no need in the branch books of classifying expenses and determining 
profit, all of which would be carried out in the home office books. 

A still further amplification of the accounting of a branch estab- 
lishment would be the keeping of such records as would permit of the 
determination of the profit and loss for the branch. For this purpose, 
it would be necessary to fix the value of merchandise supplied through 
the head office, which might be the price at which goods could be pur- 
chased in the market. It may be that the firm is a producer of goods 
and that such a price includes manufacturing profit, but if so, such a 
profit is made at the headquarters of the firm, and is not a profit for which 
the branch should take credit. Inasmuch as it is only a transfer of stock 
from warehouse to a branch, the advance over cost is an anticipated profit 
and should, to the extent of goods unsold by the branch, be held back 
from profit and loss, to be taken in later when the goods are sold. The 
ordinary bookkeeping record of expenses and losses should be kept, and 
adequate reserves for losses in the collection of accounts receivable should 
be made. 


34 


The plan of accounts is to record the advances of merchandise and 
money by the head office in a branch office account, as the capital in- 
vested in the branch, for which the head office receives credit in an ac- 
count raised in the branch books. Thus, if values to the extent of $10,000 
of merchandise and $2,o00 in cash are supplied to the branch, the entry 
in the head office books would be: 


BRANCH NOP AICTE aia dite Nipete Ye $12,000 
To PURCH ASHias iuide yap tou eum $10,000 
Baths OF ANC) FPR MOP ER EL Oy LN) evy atemyre 2,000 


The entry to open the accounts of the branch would be the inverse, 
and would appear as follows: 


MERCHANDISE ADVANCES.......... $10,000 
OAS Ee wire cree ety aan tet Re ee On Seen eee 2,000 
TOUHOME MOE LOR Sear iccen arent aee $12,000 


If the goods are all advanced through the head office the ordinary 
caption of Purchases would not properly describe the state of facts. There- 
fore, if an ordinary merchandise account is not used, the goods may be 
charged to an account under the caption Merchandise Advances, or any 
other suitable caption. 

The accounting from this stage follows the ordinary lines, the ac- 
counts receivable or cash being ‘charged, and sales credited, with the 
progress of the business. Salary and other expenses are charged to appro- 
priate accounts. Further advances from the home establishment would 
be credited to the head office account. Inasmuch as goods are advanced 
and are converted into cash without further cost than the expenses of 
selling and management, it follows that cash receipts will greatly exceed 
cash payments under usual conditions. : 

A common procedure is to have all cash receipts deposited in a bank, 
subject only to check or draft, drawn from the head office. A fund is 
supplied to the branch on the Imprest basis, which may be held and used 
through a separate bank account, for the purpose of making payments 
on account of expenses. This is replenished from time to time upon state- 
ments of disbursements rendered to the home office by check of the home 
office, usually on the local bank, in which receipts are deposited. 

A less satisfactory procedure is to maintain a local bank account 
under the control of the branch management, from which funds are re- 
mitted to the head office from time to time as conditions demand. Theo- 
retically remittances or deposits could be charged to the Head Office 
account, although it is usual to hold such items in a special account until 
the close of the period, when the balance is charged to the Head Office 


35 


account. In fact, when the less frequent condition of remittances from 
the head office exists, they may be credited to the account instead of 
to the Head Office account, in order that the cash transactions with the 
head office may be disclosed in a single account. 

In case of one or more bank accounts under the control of the branch, 
it is advisable to have the bank render a monthly detailed statement, if 
practicable, directly to the head office. 

The information required by. the home office will depend upon the 
circumstances of the case, varying from a complete weekly report of 
all transactions, including cash receipts and payments, and sales, to a 
monthly detailed report, or a monthly summary report, which may con- 
sist merely in the transmission of a trial balance, to a semi-annual or 
annual report, giving the results in detail only. It is customary to supply 
the home office with a duplicate sales record (invoices), and, in some 
cases, complete ledger accounts are maintained in the home office. A 
summary control, however, usually meets every requirement with less 
labor. ' 

If the concern has a large number of branches, it may be justified 
in maintaining its own auditing staff, which will make an independent 
report to the home office. There will, in such case, be less necessity for 
a complete report of the transactions of each branch. In the absence 
of such a staff, the same result may be obtained by the employment of 
accountants, who will certify monthly, or at less frequent intervals, to 
the state of facts existing. 

At the end of the accounting period, there is the same necessity for 
the adjustments of all accounts that exist in an independent accounting 
system, for the results must be carried into the accounts of the head office 
for the purpose of determining the aggregate profit and loss outcome, 
in which the transactions of the branch are constituent elements. There- 
fore, it is necessary to make an inventory and accrue all expenses and 
profits. The profit and loss items may be collected in a profit and loss 
account, if it is desirable, on the branch books, to show this result; if 
it is not desirable, the items may be transferred, together with the balance 
of the deposit or remittance account, directly to the head office account, 
which will then be reduced to a Statement of the exact amount of values 
invested in the branch enterprise by the head office. 


Ledger Analysis. 


The vital accounting record exists in the books of original entry 
and it is often necessary to establish the agreement of the Ledger with 
such original records. If the discrepancies are not numerous, they may 


36 


be located by calling back the postings, and corrected by entries made 
for that purpose. The ledger facts, when properly adjusted and brought 
to a state of equilibrium, may then be relied upon as the basis for the 
preparation of statements to present accounting facts. 

The bookkeeping work is so inadequate in some cases that the agree- 
ment cannot be established in this way. Part of the original entry may 
be made in the Ledger itself, and the agreement of the balance may be 
rendered difficult by errors. In such a case, it may be necessary to under- 
take the laborious task of analyzing the ledger, by which it is brought 
to an agreement with the original record. 

In order to understand the procedure, it is necessary to bear in mind 
that the ledger is an aggregation of accounts, which classify the facts 
recorded in the books of original entry, as to persons and subjects. The 
ordinary posting process is reversed and the items are carried back to an 
analysis sheet, ruled so as to show for each account the source of each 
item in the account. In this way, a statement is secured that balances 
and proves each account as the work progresses. 

Thus, an account receivable may have items as follows: 


Dr. Joun Doe. Cr. 
1902 1902 

Jan.«@\ Do} Balance aye ut $300.00 |} Jan. 5 By Allowance.... $20.00 

2" Merchandise, ... tj;o00\00 1} Heb: 6 {Gash ee 970.20 

Lou i , att) 590.00 60). Discounts een 9.80 

13 “ Bills Receivable 300.00 

28 ‘* Balance down. 500.00 

$1,800.00 $1,800.00 


The books of original entry, from which the foregoing was posted, 
were Journal, Cash Book, ruled for items of cash and discount, and Sales 
Book. A Purchase Book was also used, but no entries from it appear 
in the above. An analysis, therefore, could be made as follows: 


37 


‘uMmoys st ATUO 
UUINTOS o3ep oO ‘sIsXTeuR oY} Jo esodimd oy} Jo vopt ue Sutheauoo ut Aqror[duns Jo ayes oy} JO “sO Arenuef oy 
Aq patdnoso yey} aytsoddo sovds oy} ut poov[d useq aAvY pynod susoyr Areniqsy oy} ‘UdATSs UIO} OY} UI ‘snyy, ‘soeds 
UL SOZIUOUODS JUSUTESUeIIY Ue YoNs yey} UT [NJesn st uuMjoo AouOoW YoRa Y}IM UUINIOS 04ep & JO UOTPIOSUT OTL], 





| | | | | | | | | | | | SE 


| | | | | | | NN NN LN UN LN 


ooS¢ Qe - 
ls eee ee ee ee Se ee ee fe | ede 

eS ae cs ee ee ee ee eee (9 “ged | 

———s oo ed See gr le 
OSS a SS eS ee ee ee ee et ee ea 
ooorg “00 oofg |e uel fesse 90q uyof 
zoor 
sourleg yoog “qOsTq, yseg | souryeg || s0ue[eg “qOSTC] yseg | soueleg 
Ter [eusinof jaseyoing|——____ 315) ay jeurnof | soajeg = |————__—_ ‘Iq 

BUISOTC) yoog yseg surluedg || sursoj9 yoog yseg suluedg | 93eq yunos0V 


SollyUuy, JIPIIO jo uorzeoytsse solyuq jiqoq jo uoreoyisse 
yay Hpet) F Sal! dpe a a gs ak A Pyeousse]) 


38 


A ledger account, of course, can be made to balance by carrying the 
difference in, as was done in the ledger account shown. The manner in 
which an equilibrium is established in the foregoing analysis may be seen 
from the following: 


Items in Classification of Items in Classification of 
Debit Entries. Credit Entries. 
Balance at beginning... 300.00 20.00 
I,000.00 970.20 
500.00 9.80 
300.00 
$1, 300.00 
Balance at Closing.... 500.00 


$1,800.00 $1,800.00 


—_——~ 


Each account is treated in the analysis sheet in the same way, and 
the Dr. or Cr. balance of each is established. Each can be proved sepa- 
rately, or the analysis can be proved, as is usually the case, by pages. 
The totals of the columns, after the proof of a page, are carried forward 
to the succeeding page, so that the total debits and credits from each 
book of original entry are shown. 

The process will not necessarily result in a trial balance, unless the 
ledger is in balance. If a total shown on the analysis to have originated 
in a book of original entry does not agree with the total column of such 
book, there is evidence of error. 

Thus, the total Journal credits shown in the analysis might differ 
from a summation of credits in the Journal itself, which would render 
necessary a search for the discrepancy. In this way, errors are localized 
to a particular part of the record. A discrepancy between the totals of 
the two Journal columns shown in the analysis, too, would call for an 
explanation. The cash receipts and payments, as disclosed by the bank 
and other cash records, can be compared with the cash entries known 
to have been carried to the ledger, as shown in the analysis. It will be 
seen that the entire record is dissected and spread out in a way to facil- 
itate verification. 

The complete analysis of a ledger with numerous accounts is a con- 
siderable task, and is usually a last resort. The analysis of the most 
important accounts, however, is of common occurrence, and may pro- 
ceed along the foregoing lines or in the way best adapted to the needs 
of the case. 


a9 


Special Account Classification. 


The analyses of accounts are made to classify elements and set 
them forth for the purpose of adjustments and reports. Thus, if it 
were desirable to analyze an expense account, it could be done on an 
analysis sheet ruled with columns for date, items, total charged, and 
distribution columns for the classes into which the charges are to be 
carried. | 

An analysis of a Bills Payable Account is a more complicated ex- 
ample. It may be made in the following form: 


BILLS PAYABLE ANALYSIS. 





Settled 
Payee Amount Rate Due Date Manner 
(List all bills given) Paid or 
Renewed 


The unsettled bills would be disclosed by the unchecked items in 
the “Settled”? column. If desirable, rulings could be provided to the 
right to show items due within 30 days, due from 30 to 60 days, etc., 
but this is usually done as a recapitulation after the analysis. The ruling, 
in fact, is made to meet the conditions found to exist. 

This view of analysis is given to reinforce the principles of construc- 
tive accounting, by which the original records are planned to provide, as 
nearly as possible, all necessary classifications. 





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ee INTERMEDIATE ficou AND PRACTICE 
ie _OF ACCOUNTS. 
__ APPLIED ECONOMICS AND ORGANIZATION. 


_- By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


LECTURE IV. 


CONSTRUCTIVE ACCOUNTING. 


DA MTR AE Sy el oo On RE NG Pye CG 41 
TDEMENTSrOR: UNCOME St WN, 9 RRS Sok 42 
PROS SIN BT URNS. ie Rh Te RON a RO Oe Rael AOU 42 
CON as BM cee nae MOUS Lo Rn Red a Ue 43 
Pee ons: BP Rea NICS A oo er ec RS ag eS a a ea 44 
CLASSIFICATION GP SH LEMEN DS) ral el ot LC ite oan 47 
MIscELLANEOUS ELEMENTS Ree TE NASR S aay any at Ms 49 
GENERAL PRINCIPLES TEES dan piety Bineel Vics, pan eee 49 
PERCENTAGES ea ee ns Uh ae ee sa hue Gare, ae: 50 


CopyrRicH?t, 1914, BY 
HOMER St. ‘CratIR Pace. 


PAC Bed PACE 


PACE STANDARDIZED COURSES IN ACCOUNTANCY; BUSINESS ADMINISTRATION 
AND ENGLISH IN RESIDENCE. AND BY EXTENSION 


Fe 3p CHURCH STREET, Oy noo : NEW YORK CITY 





INTERMEDIATE THEORY AND PRACTICE 
OF ACCOUNTS. 


APPLIED ECONOMICS AND ORGANIZATION. 
PyenOMEK ST CLAIR PACK °C’ P. A.’ (N. Y.) 
ER CUGRE av. 


CONSTRUCTIVE ACCOUNTING. 


In General. 


A knowledge of specific financial facts and a comprehension of the 
effect of the aggregate of financial transactions are essential to successful 
management. In order intelligently to place a selling price upon an 
article, the specific financial fact of its cost must be known. In order 
to guide the enterprise in succeeding business periods, the effect of finan- 
cial transactions must be known by means of a display of costs and selling 
price in opposition. 

In a small enterprise in which the transactions are few, the mind 
may retain sufficient facts and financial effects for successful manage- 
ment. In this way, the affairs of petty traders are often managed without 
the aid of scientific accounting expedients. 

In larger concerns, where the transactions are more numerous, the 
mind fails to grasp the significance of the transactions without the use 
of expedients for classifying the facts in a logical manner, and for pre- 
senting, in form suitable for ready comprehension, the effects of trans- 
actions. The failure of many men, successful in the management of small 
concerns, to conduct successfully the affairs of larger enterprises, is due 
to their inability to secure facts and to comprehend their meaning. 

Accounting has for its principal object, both in large and in small 
enterprises, the securement and the presentation of information neces- 
sary to an efficient control and management. There are two distinct steps 
Copyright, 1914, by Homer St. Clair Pace. 


42 


in the process, the first of which, already considered, is the designing and 
the use of records for the collection and the classification of the facts that 
contribute to the results. The second step is the construction and the 
use of statements that will bring to the mind a complete understanding 
of the recorded facts. | 

The two basic statements are the Balance Sheet, to show the state 
of the enterprise, that is, financial facts, at a certain time; and the Profit 
& Loss Account, in one form or another, to show the progress of the 
enterprise or the profit or loss effect of financial transactions. 

This Lecture will deal particularly with the latter statement, not 
only in its final form, prepared to accompany a statement of financial 
condition, but in its incomplete and estimated form, as used throughout 
the accounting period as an aid to management. 


Elements of Income. 


In enterprises conducted for profit, a certain service is rendered, the 
return for which, it is expected, will be in excess of all the costs incurred 
in rendering the service. In this way, the invested capital is kept intact, 
and a profit is secured, the latter being the compensation for the capital 
used and the effort expended. In case the returns are less than the cost, 
an impairment of capital, to the extent of the difference, results; and 
unless there is reason to believe that the enterprise can be brought to a 
point where the returns will exceed the cost, recourse should be had to 
a realization and liquidation, to prevent a further wasting of capital. 

The statistical record of nominal elements is made, in order to have 
available the reasons for income results. They are displayed in the form 
of a Profit & Loss, or Income, Account, and their usefulness will depend 
upon the classification of returns and costs. The nominal elements in 
such a statement record two distinct things, viz.: 

1. Service rendered, for which a gross return is received, shown by 
credit balances; 7 

2. Costs of the service, which are an offset to gross returns, shown 
by debit balances. 

The first measures the gross returns, while the second measures the 
cost of obtaining such returns. 


Gross Returns. 


The service rendered may be any one, or several, of a great number 
of things. For example, the service may be trading or merchandising, by 
which sales of goods are made to customers; it may be the insuring of 


43 


goods, for a certain amount, known as a premium, against loss by fire or 
otherwise; or it may be the transportation of goods for tolls or charges. 
The measure of service would be, in the case of the trading concern, the 
sales; in the case of the insurance company, it would be the income from 
premiums; and in the case of the transportation company, it would be 
the earnings. In each instance the business transacted is measured by 
the gross return. Throughout all business, the gross return measures the 
result of the selling effort, and it supplies a ready and valuable means of 
determining facts in relation to the extension or the decrease of the service. 

As an aid to management, the gross results should be known and 
displayed at frequent intervals throughout the accounting period, as well 
as in the aggregate at the end of the period. Gross returns, whether 
received as sales, earnings, or in other forms, can be shown conveniently 
at short intervals, and provide a valuable index to the volume of business 
and the efficiency of the selling staff. 

The intervals for which facts can be displayed vary from a day to 
a year. As a general principle, the greater the number and the smaller 
the size of the transactions, the closer the gross results can be followed. 
For example, the gross earnings of a street railway, collected five cents 
at a time, but fairly constant in flow, provide a satisfactory daily display 
of gross results. The form should provide for a comparison of the result 
with some previous day. A ship-building company, on the contrary, 
may take but a few contracts a year, in which case a daily record of gross 
business received would convey but little information. Between the 
extremes are found undertakings whose gross service, according to their 
particular circumstances, can best be measured by statements covering 
weeks or months. 

The statement of gross results is easier to make than a statement of 
the costs and expenses chargeable against such results. The sales in a 
department store, for example, may be determined definitely at the close 
of the day’s business, while the determination of the costs of the day’s 
business would involve the apportionment of monthly charges, which in 
some cases would have to be estimated. In railroad accounting, as another 
example, daily gross earnings are shown, while net earnings are deter- 
mined but once a month. 


Cost. 


Gross returns in themselves are not the object of a business. If the 
gross return, or selling price, of an article is $3.00, and the costs are $1.50 
for the article itself, $1.00 for selling effort, and $1.00 for administrative 
expenses, there is, it is true, a gross return, and even a gross profit, but 


44 


» 


the net result is a loss, or impairment, of capital. In the end the returns 
must exceed the costs, to achieve the object of a profit enterprise. 

The relation of cost to return should be determined as often and in 
as much detail as practicable. In railroad companies, as before explained, 
the net results are determined once a month. In addition to the yearly 
statement of income, a monthly statement is therefore available which 
is of use in directing the year’s operations. The results are shown in 
great detail, and by means of comparison with the preceding month and 
comparison with the same month for the preceding year, inefficiencies are 
defined for managerial attention. 

The circumstances of the case should determine the frequency of 
intra-period rests. For example, once a month is often enough to prepare 
net statements for a city hotel, but similar statements for a summer hotel 
should be prepared on a weekly basis, owing to the short season, extending 
not over more than eight or ten weeks. Statements prepared on a monthly 
basis in the case of the summer hotel would be of little service in aiding 
the management to avoid an unfavorable outcome, for the season would 
be well along before the results would be in hand for management purposes. 

In trading concerns in which it is necessary to take a physical inven- 
tory, statements of net results prepared annually or semi-annually are 
usually sufficient. 

Much is dependent upon the classification of the statements. A full 
consideration of classification, including detail and form, will now be 
undertaken. 


Illustrations. 


Statements to disclose income results may be prepared in the account 
form, with debits and credits in opposition, which is a modified ledger 
account form; or they may be prepared in running or report form, the 
net results being obtained by subtraction. The latter form is coming 
into common use, and is justified on the ground that it is less technical 
than the account form, and, therefore, the accounting facts are more 
readily comprehended by those not technically trained. An additional 
reason for the use of the report form is that it can be used more conveni- 
ently in printing and in the typewritten reports that are now generally 
used to present such facts. 

The report form will be used to show the uses of classification in 
recording and presenting facts as to income. 

The simplest condition in the accounts of a trading concern would 
be the subtraction from an ascertained amount of Gross Profit, of the 
total Expense incurred, thus: 


45 


PROFIT & LOSS ACCOUNT. 


Gross Profit (balance of Merchandise Account)................. $221,500 
Brera Tesees «tr AUER SAY eed RO BL Ee SE 176,300 





RicwProie Kamion. # Fe ik SR OM SLN 8 A $45,200 


The elements that enter into Gross Profit may be of value in de- 
termining the relation of cost price to selling price, and this could be 
determined by an analysis, preferably by means of accounts raised during 
the accounting period, or of the Merchandise Account. The classifica- 
tion of expenses might also be an aid to management. The information 
could be presented in this way: 


TRADING AND PROFIT & LOSS ACCOUNT. 


Bom, Periodt...t Tasik 3 2 Pe iss 
MERLE or chitin Go Cr oy LEY BAUR, Sul MRI kU. $664,500 
MOU At OCOININNS in ee eee A aie $ 87,000 
Beer TICE arias sk, ee, Get a be wie oe eels 425,000 
$512,000 
eer OUVENSOLY, AL CIOSG/ NER uc. eee oe ees 69,000 
RPE D OLS SOL Louse de 2”. 1. ty be. v fhdie we Hae ee eae 443,000 
Pre -COECOnIA ASE OTL OALCS) a 4, pon ecwergaine 5 hme $221,500 
Expenses: | 
Or SR ane he's 6 on oe gs ase ha ale sere $98,000 
ODES RE ERT PEO BIS (aap ean aS Re oie Si RE INDY 63,000 
er ee ER ee sb os ak ra ie eat ad anes ake 15,300 176,300 
SMe RET Le i oy. iin ac ani 6: Ca BV ER Ute eat eee RS $45,200 


From the foregoing statement, a fairly complete idea of the trading 
that gave a gross profit of $221,500 may be obtained, as well as a general 
classification of the expenses. The expense amounts are large, even as 
classified, and a further classification is desirable. The statement, there- 
fore, will be recast, the returns and allowances will be shown in the trad- 
ing division and expenses will be analyzed more nearly as would be the 
case in practice. 


46 


BLANK & BLANK. 
Trading and Profit & Loss Account for Year Ending December 31, 1902. 


TRADING. 
Sales ois SP Sees eA Pe oA ater eet een $667,000 
Less: 
Rétatnses esi 2h te ae es See ene $1,800 
Allowancessiec so isc4 ra oe eee a 700 2,500 
Net: Sales... oct ccwie sales aieg anes Kode cds hae On anne nn 
Inventory, January 11902.) een eens eee $87,000 
Purchases iro ch tog oe ee ee ee $426,500 
Less: 
Returns) hi00 7 es SRA ao * 1,500 425,000 
Less: $512,000 
Inventory, December 31) 390200. 3) te eee 69,000 
Cost'of Goods Sold 34...) 35.0906 ae a 443,000 
Gross Profit, carried to Profit & Loss Account 
below, being 333% on Net Sales.............. $221,500 
ProFIT & Loss. 
Gross Profit on Trading sv. is 5) (25.284 0 et ee ee $221,500 
Selling Expense: 
Salaried Fee vita poke are eee Ce $52,500 
Entertainments:), 232). 2 pone eee 3,500 
Publicity: 
Magazine. 7336 ce ee $31,500 
Newspaper ives scusa nate 7,500 
Circular Cir C 0 int eee 3,000 42,000 $98,000 
Administrative Expense: 
Salaries: 
Manapition (soi, See $28,000 
Clerks) et ae A ee 29,200 $57,200 
Stationery...) 40 F095 Oi A eee oe 2,200 
Printing «4.625304 A ee ee ee 1,100 
Miscellaneous) iii) 2634 eee 2,500 63,000 
Capital Expense: 
Discounts. <4). eee eee $4,100 
RONG el ie eS id ince ate A ee 6,000 
Interest? a eee 800 
Reserve for Bad Debts... 490% UU2...54 1,100 
Insurancely ati 25) eee 1,800 
“Daxes pat. bekt lil, PAE, eee se 1500s. 15.300 


Total: Expenises « 0.54; Zee Base eter aed. eres ee $176,300 
Net: Profite:):. 23 oe Bee een eL ak erat $45,200 


47 


Classification of Elements. 


The greater usefulness of the statement last given over preceding 
statements is obvious. The elements stand out in a way that aids in an 
understanding of the causes that have brought about the net result. 

In the first statement, the gross profit was shown, with no attempt 
whatever to present the elements of trading. In the second statement, 
the sales and purchases were shown by net amounts, but the information 
as to gross trading was in other respects fully presented. In the third 
statement, the gross amounts of sales and purchases were shown, and the 
returns and allowances deducted therefrom, presenting clearly features 
that might be of great importance in disclosing certain elements that 
contribute to the outcome. 

In the part of the statement that presents expenditures, it will be 
noted that the general classifications of Selling, Administrative and Cap- 
ital have been amplified by details, showing the classes of expenditure 
-ineach. Thus, Selling Expense with a total of $98,000 is shown to have 
been divided into Salaries, Entertainment and Publicity, and the latter 
item is subdivided into three classes. If the entire amount of $98,000 
seems large in comparison with the estimates, or with the expenditures 
of a previous year, the causes of the increase could be traced. It would 
be of importance to know whether it was incurred in salaries or in pub- 
licity, not alone as an index to the past record, but on account of its 
importance as a guide for the future. For example, if the Publicity 
expenditure had largely increased with no appreciable increase in gross 
sales, the management might be led to reduce the expenditure for that 
item in the succeeding accounting period. Classification of this division 
in a large undertaking might be made much finer, and the division shown 
is for illustrative purposes only. 

In a general way, the comments in regard to Selling Expense apply 
to Administrative Expense. The details that enter into this large amount 
of expenditure are of importance, in order that such expenditures may 
be controlled and that they may be made to produce their full value to 
the business. 

The third division, designated Capital Expense, is one that, perhaps, 
calls for more comment than either of the other two classifications. The 
attempt is made to group under this division those expenditures that are 
incurred on account of the conditions that exist in regard to capital. 

Thus, there is a debit balance to discounts which measures a net 
abatement of amounts due the concern, given in consideration of cash 
settlements. For example, a bill for $500, settled before its due date 
under 1 per cent. discount, would produce but $495. There may be in 


48 


the Discount account the credits that arise from the settlement of liabil- 
ities under a discount or abatement, allowed for cash settlement. The 
object, in the case of the discounts given, is to secure cash before it is 
due, and in the case of the discounts received, the payment is made, 
because there is sufficient cash on hand to make available the saving or 
abatement. These two conditions, theoretically, flow respectively, from a 
small or insufficient amount of capital, or an abundance of capital, and 
the amounts are not apt to vary on account of trading conditions. The 
inclusion of such items, therefore, in Selling Expense, might distort that 
division by bringing into it an element that would fluctuate quite regard- 
less of the conditions that exist in the selling department of the enterprise. 

In case discounts taken were kept in a distinct account, with a credit 
balance, it would, in many cases, be advisable to. deduct the amount 
thereof from the total of Capital Expense, rather than carry it to the 
Trading Division as income. In theory, it is an offset to Capital Expense, 
and is never actually received as income. 

The item of Rent is handled, in theory, upon the same basis. Thus, 
if capital sufficient to supply all real estate facilities were provided, the 
item of rent would not exist. 

The item of Interest, is, in theory, the same as Discounts, and arises 
through a scarcity, or an abundance, of capital, and calls for no special 
comment. 

Reserve for Bad Debts is included in this division because it is a loss 
that is expected in the realization of assets. It might seem, inasmuch as 
the accounts receivable are estimated to produce an amount less than 
their face, that the shrink should be deducted from the amount of sales, 
or included as a selling expense. The credits upon which the sales are 
based are passed upon by the credit department. To deduct subsequent 
losses in realization, which might, in some cases, be due to financial strin- 
gencies, for which the selling department is in no way responsible, would 
seriously impair the statistical value that is secured in the record of sales, 
It is, in the first place, an estimated amount and in view of this, care is 
taken to insure a liberal provision. This would necessitate adjustments 
to correct the estimates, which would bring into the matter a fluctuating 
element that is best handled through some special classification that does 
not impair the statistical value of the other divisions. 

Insurance expenditure is incurred for the purpose of safeguarding the 
capital, and the item of Taxes is an imposition by the Government on 
account of the investment of capital, so that both items may properly 
be carried into the classification of Capital Expense. 

The summation of the totals of the three classifications produces 


49 


the amount, $176,300, to be deducted from the gross profit, $221,500, 
which leaves the amount of net profit shown in the preceding statement, 
namely, $45,200. 


Miscellaneous Elements. 


There are numerous items not included in the foregoing statement 
that may occur in practice. Thus, it is not unusual to find an expen- 
diture on account of duty or freight on goods received. Such items would 
be shown in the Trading statement as an addition to the purchases, inas- 
much as the cost to the concern is the total amount which accrues up to 
the time the goods are received in the stores or warehouses. The object 
is not to show the cost of goods at Liverpool, or at Manila, but delivered 
to the concern and available for its uses. 

Freight paid on goods shipped out, in the majority of cases, would be 
charged to the customer, but in case the sale were made on the basis that 
the goods be delivered at the destination, the freight thus paid would, 
in theory, be a deduction from returns. It would, perhaps, be better 
handled in this way than carried as a charge to Selling Expense, inas- 
much as it is strictly a transportation, rather than a selling item. 

Trade Discount, that is, a deduction from a nominal list price, whether 
allowed on goods bought or goods sold, ordinarily is not entered in the 
accounts in any manner. If such items are entered, trade discounts on 
goods purchased should be deducted from purchases, and trade discounts 
on goods sold should be deducted from sales. 

Sufficient items are given to show the application of the principles. 
In practice, the specific instances are innumerable, but the governing 
principles are few. 


General Principles. 


The divisions into which expenditures are classified will vary accord- 
ing to the requirements of the particular enterprise. It is desired to lay 
emphasis upon the fact that such divisions should be made for a concern 
only after an investigation by the accountant that will enable him to 
pass judgment upon the specified conditions. The general heads might 
be more numerous and the detailed classifications of each might extend 
much further. 

As a general proposition, a large volume of transactions is necessary, 
in order to render desirable an extended classification, and in the accounts 
of small traders any division further than Trading and general Profit & 
Loss is likely to be undesirable. With these two general divisions, and with 
possibly a third division in which any extraordinary item of profit or 
loss not arising from trading or operation is included, all the facts essen- 


50 


tial to an understanding of the progress of the concern can be obtained. 
The classification, once made, should be maintained strictly, in order 
that each classification may have a statistical value through comparison 
with previous accounting periods. In the Trading division no items 
should be included except those that fluctuate as the volume of business 
fluctuates, for items that are fixed in their nature, irrespective of the 
volume of business, would tend to distort the gross result of trading, for 
the presentation of which the Trading Account is created. 

In the handling of accounts of small traders, and in the solution of 
propositions in which the facts are imperfectly stated and the classifica- 
tions are not made to a fine degree, the attempt to classify into Selling 
Expense, Administrative Expense, Capital Expense, etc., is to be avoided. 
Resort should then be had to the Trading and Profit & Loss Account ar- 
ranged in two or three divisions, as stated, with the disposition of the net 
profit shown after the determination of trading and profit and loss results. 

Attention is called to the necessity for records constructed for the 
purpose of making the necessary classification as the bookkeeping entries 
are made throughout the accounting period. Without such provision, 
classified statements can be prepared only by work that amounts to a 
restating of the entire bookkeeping record, which the accountant is often 
called upon to do, although it is an expensive process. The close relation 
between the designing of records and the presentation of accounting facts 
will, therefore, be apparent. 

Percentages. 

The use of percentages in stating trading results, and in calculating 
profits, both gross and net, has the advantage of conveying to the mind 
relative facts more fully than is possible by the presentation of specific sums. 

In the preceding statements, the gross profit, calculated on selling 
price, as is the practice in the retail trade, is shown to be 334 per cent., 
the figures purposely being worked out to produce a percentage that would 
be convenient to illustrate the principles involved. In case an article 
is sold for one-half, or 50 per cent., more than it costs, the trader places 
upon it the selling price and then considers the gross profit to be one- 
third, or 334 per cent., of the selling price. Thus, an article bought for 
$500 is marked for sale at $750, or an increase of 50 per cent., and the 
trader considers that he is selling upon a gross profit basis of 334 per cent. 
In case of stable conditions in the trade, the prices permit of a fairly uni- 
form basis of gross profit, and it can be determined on any specific article 
by mere multiplication of the selling price by the rate of profit. For 
example, 333 per cent. of $750 is $250, the gross profit, which, deducted 
from the selling price, $750, will leave $500, the cost price. 


51 


The principles apply to the aggregate transactions, so that a rate of 
gross profit may be determined. In the accounts common to traders, 
the actual cost of sales is not known except at the time a physical inven- 
tory is taken. Between the times of taking physical inventories, if the 
approximate percentage of gross profit on sales is known, the cost of the 
goods sold may be determined by multiplying the amount of sales by the 
rate of profit, and deducting the amount obtained by such multiplication 
from the selling price. The amount of cost of goods sold deducted from 
the amount of purchases, including opening inventory, will leave an 
amount that is the approximate inventory of merchandise on hand. This 
is a convenient expedient for the purpose of making estimates of trading 
results from time to time during the accounting period, and in case of 
the destruction of the stock on hand by fire or otherwise, the amount 
of goods destroyed may be approximated in this way for the purpose 
of insurance adjustments. 

There is a case on record in Great Britain in which auditors were 
held in damages for failure to detect fraud in inventory that would have 
been discovered, had the inventory been tested upon the basis that has 
been explained. 

The advantage in calculating percentages upon the basis of sales 
lies largely in its convenience and in the matter of estimated inventory. 
The soundness of the method depends upon the approach to accuracy of 
the rate that is used. The selling prices are, in many instances, subject 
to adjustment before actual sales are made and are controlled in the long 
tun.by the economic lawof supply and demand, rather than by the action of 
traders in arbitrarily fixing prices that exceed the cost prices by a certain 
percentage. It is only when these variations can be averaged and brought 
to a close approximation of the actual percentage of gross profit that the 
method of determining inventory and trading results is of value. 

In certain undertakings, the calculation of profits upon cost figures 
produces better results because the costs are definite and, once incurred, 
are not subject to changes. In the retail trade, however, the calculations 
are made upon the selling price, and the traders and their associates think 
and deal in percentages upon selling prices, so that a condition exists that 
renders desirable the presentation of results upon the selling basis. 

There are certain dangers that come from this method that should 
be held in mind by the accountant. Thus, when a trader speaks of a gross 
profit or a net profit, it is usually upon the sales, which are sometimes 
known as the turnover, and not upon the investment. A 10 per cent. net 
profit upon turnover might be a 40 per cent. profit as the term is used 
in the ordinary sense of a return upon investment, in case that the turn- 


52 


over of the business is four times as great as the amount of capital em- 
ployed. 

Another condition that may lead to an error is the use of a percentage 
to measure the expenses, which is calculated upon a selling price that is 
greater than the actual price realized. Thus, in the case before given 
in which an article was purchased for $500 and sold for $750, it may be 
assumed that the expenses were 20 per cent. of the selling price, in which 
case the elements of the transaction would be disclosed as follows: 











Selling Priel 2? , Rata (ea es, hee 100% $750 
Cost ‘of Articleyiiese. WH Sea Wieeee Beda ce 662% $500 
EXPense #a'sie'die te ive Yintad Dail cig ee eae gees PA Ar ES 
Net (Profitviohs ik Oe Sth a centen ee ee 134% 100 

100 % $750 


er 
—_ 








In case trading is being done upon the theory that the expenses 
amount to 20 per cent., based upon selling price, a reduction in selling 
price will necessarily increase the percentage thereof that must be cal- 
culated as expense. In order that this condition may be more fully appre- 
ciated, the following tabulation is given, showing the percentages applic- 
able to different selling prices, assuming that the expenses remain the 
same amount: 


$750 $700 $650 $600 


Basis Basis Basis Basis 
Cost of Article ($500). 66.67% 71.43% 76.92% 83.34% 
Expenses ($150)....... 20.00% 21.43% 23.08% 25.00% 


100.00% 108.34% 
Net Profit po: ba ee 13.33% 7.14% 00% 8.34% (loss) 


100.00% 100.00% 100.00% 100.00% 


In case of aggregate transactions, if the prices are held up to the 
required point, the estimated percentage of expenses may be used with 
a fair assurance of approximate accuracy, but the principle given that 
reductions below such prices increase the percentage should be borne 
in mind. 








: INTERMEDIATE THEORY AND PRACTICE 
OF ACCOUNTS. : 
APPLIED ECONOMICS AND ORGANIZATION. 


By HOMER ST. CLAIR PACE, ©. P. A. (N. Y.)_ 


LECTURE V. 


PARTNERSHIP. 

Me GENERA Gy ce Whar ee Pes Se le Aan Epes 
SGU RAW PROVISIONS 0 4 Coe ee ee pe seee: 53 
(PeIAL ENTRIES AND ADJUSTMENTS 2.20 lec 25.) Se. ee ee 56 

DissOLuTION ADJUSTMENTS eM hea PSION iia asain er dpc amet. RONG east TE 59 
| DisTRiBUTION: Ge CO MBIPAT: LOSS Ege. 0108 Aiea Or ek gg 63 

PROT oe or ok eka Ge ieee ia eee eee a 


COPYRIGHT, 1013, BY 
HomeER St. CLaiR PAceE, 





INTERMEDIATE THEORY AND PRACTICE 


OF ACCOUNTS. 
APPLIED ECONOMICS AND ORGANIZATION. 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


LECTURE V, 
PARTNERSHIP. 


In General. 


The relation, known as partnership, created by the association of 
the capital and effort of individuals, furnishes a common and useful form 
of business organization. The essential principles and accounting dis- 
tinctions have been presented in previous lectures, and need not be 
restated. 

A consideration of the rules that apply particularly to the keeping 
and stating of partnership accounts, as they have been developed by 
usage and judicial decisions will, however, be of use to the student, and, 
as an aid thereto, the application of the rules and principles to numerous 
states of fact will be undertaken. 


General Provisions. 


_ It has been repeatedly held that where members of a firm have access 
to the books of account and opportunity to know how the accounts are 
kept the presumption is that they do know, and the firm accounts kept 
by the firm’s bookkeeper are therefore competent evidence between the 
parties. Entries made in partnership books after the dissolution of the 
firm have been held not to be of themselves prima facie evidence against 
the partners. : 

It has been held that the annual adjustment of the books of a firm, 
in the absence of fraud or mistake, binds the partners. 

It is competent for the representatives of a deceased partner and 
the survivors to adjust and settle, by agreement between themselves, 
the partnership affairs, without an accounting or resort to legal proceed- 
ings. Such settlement, in the absence of fraud, is binding upon the parties 
Copyright, 1913, by Homer St. Clair Pace. 


54 


to it, subject to be opened for the correction of errors or mistakes, in 
accordance with the practice and principles of courts of equity. 

In general, a partner is not entitled to charge his copartners for 
services rendered in the management of partnership property or business 
unless upon special agreement to that effect. A managing partner is not 
entitled to salary in the absence of an agreement to pay it, and one part- 
ner cannot charge the firm with commissions on sales in the business 
without such an express agreement. 

From an accounting viewpoint, in the determination of net profit, 
salaries to partners are not ordinary costs or expenses, but advances 
against profits. The line between that which a partner “earns” as a 
salaried man, and that which he receives as a proprietor, is arbitrary, 
and should not be allowed to affect the showing of the net trading results. 
It may, of course, be called an expense to give effect to partners’ agree- 
ments inter se, but the real accounting effect of such a procedure is an 
advance against profits. 

It is the duty of a surviving partner to wind up the affairs of the 
partnership and to account for, and pay over, to the personal represen- 
tatives of the deceased partner his share of the partnership effects. 

If, by the continuation of the business, the assets and stock of the 
old firm have become mingled with new stock and its identity lost, the 
court will impress the equitable lien of the representatives of the deceased 
upon the whole of the new stock except as against a bona fide purchaser, 
or a party having acquired a specific lien, and such equitable lien will 
be enforced to the exclusion of the individual creditors of the surviving 
partner. 

On the death of a partner, the survivor, for all practical purposes, 
takes the legal title to the partnership property and the place of the firm 
in respect to its assets and liabilities, and is vested with the possession 
and management of the property for the purpose of closing up its affairs. 
And the primary liability to pay the firm debts is that of the survivor. 
The remedy of a creditor at large of the partnership is against him alone 
unless he is insolvent. And in that event, or when the legal remedy has 
been unsuccessfully exhausted against the survivor, the creditors may 
proceed in equity against the representatives of the deceased member of 
the firm and his estate. The burden is upon the creditor to establish the 
facts which afford the right so to proceed. 

Upon the death of one partner the surviving members of the firm 
become the legal owners of its assets by virtue of their survivorship, and 
have the exclusive right to sell, mortgage and dispose of them in the per- 
formance of their duty in closing up the affairs of the partnership and 


55 


can do so in the manner they deem best for the interest of those con- 
cerned. The representatives of the deceased partner have no legal interest 
in such assets, and no legal right to interfere in their administration, so 
long as the survivor is prosecuting the business of closing up the estate 
and applying its proceeds in the payment of firm debts. The survivors 
do not take such assets as trustees, but, as survivors, hold the legal title 
subject to such equitable rights as the representatives have in the due 
application of the proceeds. They may therefore, require the application 
of the assets to the payment of partnership debts, but the time, manner 
and mode of doing so are a part of the administration of the estate which 
is under the exclusive control of the survivors. | 

It has been held that a surviving partner may in good faith borrow 
money for the express purpose of paying debts of the firm. A surviving 
partner cannot take the property of the firm to himself at an estimated 
value, without consent of the representatives. He is bound to sell it to 
the best advantage. 

Where, upon death of a member of an insolvent firm, the surviving 
copartner, who was solvent, was obliged to pay the firm debts out of 
his own property, and the separate estate of the decedent was insuffi- 
cient for payment of all his debts, held, that the balance due from the 
decedent’s estate to the surviving copartner, on account of the partner- 
ship transactions, must be paid ratably with other debts of the same 
class. 

The law imposes upon the surviving partner, as an incident to the 
contract of partnership, the duty of collecting the assets and winding 
up the business of the firm, and allows him no commissions for its per- 
formance, unless specially provided for by agreement. 

In the absence of an agreement, express or implied, that the surviv- 
ing partner shall be paid for winding up the dissolved partnership, as in 
the case of the continuance of the partnership business with an interest 
in the profits to the representatives of a deceased partner, such surviving 
partner is not entitled to compensation for such services, and the same 
rule applies to the liquidating partner on a voluntary dissolution of the 
firm. 

On dissolution by one partner becoming insolvent, the remaining 
partner has not a right, as a matter of course, to close up the business 
as would be the case with a surviving partner. The copartner has a right 
to demand the appointment of a receiver. But the solvent partner ought 
to be appointed receiver if he will give security necessary, and his capac- 
ity and integrity are unquestioned. 

Upon dissolution of partnership between S. and P., it was provided 


56 


that S. should close the concern, and, after paying all debts, take to his 
own account, from assets or effects of the firm, an amount sufficient to 
equalize the accounts of the partners, P. being indebted to the firm. The 
assets were supposed to pay the debts and equalize the accounts, but this 
proved not to be the case. Held, that P. was not discharged from per- 
sonal liability to S. for deficiency of effects. 

A retiring partner, who guarantees to pay one-half of the amount 
of notes and accounts due the firm if they prove to be uncollectible, is 
liable therefor if the debtors are not of financial ability to pay, though the 
liquidating partner has not recovered judgment and issued execution. 

The out-going partner, engaging to pay one-half of any outstanding 
accounts, “not collected or collectible,’ to the continuing partner, is 
bound to make payment on an account placed in the hands of an attorney 
for collection, and which he did not succeed in having satisfied within 
five months after it matured, though no action was brought. 

Where a retiring partner transfers his interest in the partnership 
effects to an incoming partner, the new firm holds the partnership prop- 
erty charged with a trust for the payment of the old firm’s debts, and 
the old partners cannot enforce contribution from the retiring partner for 
the payment of such debts, without showing that the partnership assets 
have been applied to and were insufficient to pay the same, since so far as 
those assets are sufficient to pay the debts the retiring partner, as between 
himself and his old partners, is a mere surety. Hence, a partner who had 
individually acquired one of the old firm’s notes cannot hold the retiring 
partner thereon unless the firm assets were insufficient to pay it. 


Initial Entries and Adjustments. 

The usual and uncomplicated condition at the creation of a part- 
nership, is the contribution, by the respective partners, of assets of agreed 
values. The amount of the agreed value of the assets contributed by a 
partner as capital is credited to his capital account. 

The value placed upon certain assets, contributed to be realized for 
partnership purposes, may be tentative, or provisional, pending such real- 
ization. Thus, accounts receivable amounting to $12,500 may be con- 
tributed with the understanding that they will realize, after allowance for 
all discounts, bad debts, etc., the sum of $10,000, and that any deficit 
will be made up by the contributing partner. The agreement might also 
provide for an additional capital credit, in case of an excess realization, 
or, in fact, the value might be finally agreed to at $10,000, the partner- 
ship as a whole to receive the effect of the realization. 

In case of a tentative valuation, subject to adjustment, the assets 
would be set up at their face value and a reserve created for the amount 


57 


by which the face value exceeds the estimated realizable value. Losses 
in realization would be charged to the reserve. In case the assets realize 
the exact estimate, the reserve will be exactly extinguished. In case of 
an excess realization, the reserve will appear with a credit balance, and 
in case of an under realization, it will appear with a debit balance. The 
balance will be treated in accordance with the particular agreement. 

As an example, A and B form a partnership, profits and losses to 
be shared one-third to A and two-thirds to B, A contributing real estate 
of the agreed value of $25,000 and B contributing $2,000 in cash and 
the Good-will and accounts receivable of a business. The accounts receiv- 
able amounted to $18,000, which B guaranteed would realize at least 
$16,000, and it was agreed that the Good-will should be valued at an 
amount sufficient to bring B’s capital to an amount equal to A’s capital. 
The accounts receivable realized $16,500. The entries necessary to carry 
the transactions into the books would be: 


A & B. 

Partnership formed by A and B this 2nd day of January, 
1902, for carrying on trading business, profits and losses 
to be shared one-third to A and two-thirds to B, capital 
being contributed as under: 

SUNDRIES To SUNDRIES 


Bag ey A ty a (CeSCTIPLIOT ya la A ahr ola ae $25,000 

OORT ES (Rag RG Ch ie ae Ee eae $25,000 
For capital contributed. 

rrr RIC MLV ADU Eo i. otis eke eee 18,000 

ee ree es ee eae AE ain. OY ete Vi: 2,000 

PRR Re es 0S ela LS eS de a Oh a 2G 7,000 
RESERVE FOR ACCOUNTS RECEIVABLE.. 2,000 
BAO A Chast: yeaitegoln sch «i couse) aigtulatd my dere aya ants 25,000 





For capital contributed. 


ERE eg ae TY PN oe) WE DP edt: $16,500 
Bee boom BiG B TVA BL Beil icd ikun ecu ted Si $16,500 
For realization. 


ReouR Ve FOR. ACCOUNTS. RECEIVABLE... 2...:. 2,000 
TOU Petits VABUE. 2) ce cam osiaearels « 1,500 
For losses in realization. 
MUO e VI rte cs ccs so tite eee ele ee mee a 500 
For excess above estimated realization, writ- 
ten off. 


58 


In case of the accounts receivable realizing less than $16,000, B would 
have been obligated to bring into the partnership the amount of the 
shortage, so that, at the outset, it is known that B, through accounts 
or contributions, will bring in $18,000. The difference between the 
$18,000 and the amount contributed by A, $25,000, being $7,000, is the 
tentative amount at which the Good-will should be carried in. The 
accounts receivable produced $500 in excess of the estimate, so that 
the value of Good-will was overstated to that amount. 

It should be noted that there was no agreement as to the value of 
the accounts. Had it been fixed at $16,000, the agreed value of the Good- 
will would have been $7,000, and the $500 would have been a firm profit, 
to be apportioned as any other profit, one third to A and two-thirds to 
B. In this case the Balance Sheet would have shown. 


Balance Sheet of A & Basat.......... 


Real Retate...... 6 oe $25,a0q A, Capital 91) .v5i. 2G $25,166.67 
Cash oe AS Seo ee eee 18,500 “3B, Capital... .<. > meee 26,333,44 
Good=will}< 3 isa serie ee 7,000 

$50,500 $50,500.00 








In comparison with the foregoing, the Balance Sheet, under the 
actual conditions, would have shown: 


Balance Sheet of A & Bas at.......... 


Réal Estate... ..55425 5035 $25,000. -A, Capttali..ii. 0870 $25,000 
Cash" xtc ewan 18,500 -By/ Capitals. Pliio2 see 25,000 
Good-wilh?t So Viter: ii: 6,500 

$50,000 $50,000 














Under the agreement, therefore, the better the results of realization, 
above the amount guaranteed by B, the less he receives, nominally, for 
his Good-will, although the substitution of cash for Good-will undoubt- 
edly strengthens the financial position of the firm and his own interest. 
The actual value of the Good-will is not lessened in the slightest by suc- 
cess in collections. 

The division of the $500 as a profit would have been better for B, 
had it been possible. The balances of the capital accounts measure the 
respective proportionate interests of the partners in the partnership assets, 
and, while in the second balance sheet the interests are shown to be equal, 
in the first balance sheet B’s interest is shown to be slightly in excess of 
A’s, due to his preference in the division of profits. 

It is necessary, in cases of this kind, to handle the contributed ac- 
counts receivable in such a way that a distinction may be made between 


59 


realization and trading transactions, For this purpose a separate ledger 
may be used for the accounts taken over, care being taken to see that 
receipts from customers are properly applied. 

The discussion of further illustrations of opening entries and adjust- 
ments would lead to but one conclusion, namely, that the difficulty lies 
in the interpretation of the partnership agreement. In seeking for a 
reasonable interpretation the accountant should carry through the possible 
accounting processes, in order to study their respective effects. By the 
exclusion of interpretations that bring about improbable or absurd results, 
the field is narrowed and the reasonable accounting intent gathered. 


Dissolution Adjustments. 

The accountant is most often called upon to determine accounting 
facts at the time of dissolution. A typical example of the complications 
that may arise in the settlement of a small partnership is supplied by a 
proposition given in an examination. The facts, fortunately, were not 
in dispute and are clearly stated. The proposition follows: 

S and T began business August 1, 1899, S investing $8,000 and T 
$5,000, gains and losses to be shared equally and no interest allowed on 
investments or charged on withdrawals. The firm was dissolved May 
1, 1900. The books had been kept in a haphazard fashion but the part- 
ners agreed to the following statement which was submitted for settle- 
ment: net debit of S $2,100; net credit of T $3,500; cash on hand, $3,400; 
to shares bank stock (market value $1,100); expense debit $5,100; profit 
and loss debit $3,000; credit $500. The bank holds the firm’s note for 
$2,000 on which there is accrued interest $60. Prepare a statement show- 
ing the settlement of the partnership affairs of the firm. 

Inasmuch as the assets, liabilities and relative capital interests of 
the partners are known, a balancing statement may be produced, as a 
basis upon which to work, by the use of whatever nominal amount is 
necessary to effect the balance. 

Thus, if X contributes $100 and Y $200 and the profits and losses 
are to be shared equally, and there remains only $100 of assets, a balanc- 
ing statement can be made that states the facts, as follows: 


RS Rte oS e-gsacc) a alas odio oe $100 
eee ee gi 8 SS oo oka ae; $100 
eats ements? ois th eh AR Seas AVE es 200 
$100 $300 

SOTIGE LOSS alc. yw ste dD vo eee Oe Oe 200 


$300 $300 


60 


The loss carried one-half ($100) against each partner would exactly 
offset X’s capital and leave the books thus: 


Assets iiaets ecceebaiee $100 TYE ge SO OS Ee $100 


Upon the withdrawal of the assets in settlement of Y’s interest, his 
account would be closed by a charge and assets would be credited to 
balance. 

Again, had X and Y brought their accounts to a position where X 
had overdrawn by say $100 and Y had a credit balance of $400, and the 
condition as to assets and liabilities was that the concern possessed $100 
and had no liabilities, a balancing statement could be prepared thus: 


Assets ic: aka a bya aud aati e fiends GPa $100 

PaSe PEET CCN, TR REE  aed Pee, Peep 100 
i See I RE PR a be me PDS POS Fee $400 
$200 $400 

Balance (10S8)\. «tee ee ere eet ae 200 
$400 $400 


The loss, carried one-half to each, produces a debit to X of $200 and 
a credit to Y of $300. Y would be entitled to take the $100 and to collect 
$200 from X, who evidently drew out the $100 he contributed and $100 
in addition, and who is also chargeable with one-half of the losses. Y 
evidently increased his contributions to $400, and after deducting his 
share of the losses, he is still entitled to the return of $300, as stated. 

Therefore, the relative weight of capital contributions or deficien- 
cies being established, and the assets and liabilities being known, a bal- 
ancing statement may be prepared by carrying in assets and capital 
deficiencies as debits, and liabilities and capital contributions as credits, 
and a nominal amount to balance. 

In case a portion of the nominal elements are known, but not all, 
such as are known are carried in and a nominal account is set up for 
whatever balance is necessary to secure the equilibrium. 

Thus, in the S & T proposition, a balancing statement can be pro- 
duced, as follows: 


CSU SER AR aA. a AP dei $2,100 
d bere anemia ey Geigte tc pa ae eee ee $3,500 
HE RRC Es OL TNT EN RCN ee eaeRa ony Wem 3,400 
Bac LOG ieee ante oo gk Ui |, 1,100 
LEXDCTISO ener ee. Lee PANG 5,100 
ONE QR an runt rr 100 eo fe 3,000 500 
Eiicel ue iovmmem mati: (cet deat rs. 2,000 
PCOrueds Interesure an Tek ohh yee 60 





$14,700 $6,060 
BAsHeeretTOub Oc LOSS ayes <u « 8,640 


$14,700 $14,700 


The nominal elements, including the balancing amount, may be col- 
lected in a Profit & Loss Account, thus: 





Dr. PROFIT & LOSS ACCOUNT. Cr 
Oo 1G Ser Pr OCCMM INV SEIANCOA fol tht oily Ui aaen $8,640 
MUM IICC 0 ke ee ge e's LOO MNS TEC LGN alts glares tia mea 500 
Papeete Profit) 22. . $520 
pele tnalt profit). 2.2. 520 1,040 
$9,140 $9,140 














The Balance Sheet, after payment of the liabilities, would be as 
follows: 








ene vad be 
Balance Sheet as at.......... 
eee eke ee eae PEAS TL eS ee a ee $4,020 
LOU Sa a 1,100 
S, Capital (deficiency)...... 1,580 
$4,020 $4,020 














In case T took over the assets on account of his capital interest the 
Balance Sheet would be: 
© & T. 
Balance Sheet as at.......... 
5S, Capital (deficiency) ...... $1, S801, Capital t we we) etek a don $1,580 


That is, S has drawn out all of his own capital and $1,580 contributed 
by T, so that he is indebted to T in that amount. = If paid into the firm’s 
accounts, Cash would first be debited and S credited, and then T would 
be debited and Cash credited to close the books. 


62 


For greater fullness, the capital accounts, as they would appear in 
the ledger, are given, as under: 












































Dr: o. Cr. 
To Balance: Fo Rae $2,100 By Profit & Loss... 2. eaee $520 
Balance, : sous } <0) eee 1,580 
$2,100 $2,100 

LO Balancgy. ai: eeeeaeiae © $1,580 
bye he Cr. 
To Cash ort os car eae nae eee $1,340 By‘Balance...>.. 77g $3,500 
“Bank: Sh0gk 2 SP et 1,100 .~~ Profit & Loss-35 ee 520 

$2,440 

. sBalance; 3 fa.ee wee eee 1,580 
$4,020 $4,020 
By Balance! ° : ieee $1,580 


The proposition can be worked on a single entry basis, although 
the double entry basis is to be preferred. However, to corroborate the 
solution and to present the resource and liability view of it, the single 
entry solution will be given. 


Total S i 
Capital ‘Contribertions: .8 5 $F, 22) SPUR eae $13,000 $8,000 $5,000 


Withdrawals.2) o. Pai APs ae ee 11,600 10,100 T,500 


$1,400 —$2,100 $3,500 
Remaining Capital: 


Cash): .’.4.4 Woes) enna at nee $3,400 
Bank Stock... .+., sunenien aaa 1,100 
$4,500 
Less. 
Laabilities. yc) 8 Se eee 2,060 2,440 


Net Profit, half toveach seo. eee $1,040 520 520 
— $1,580 $4,020 


OF) ee SPE poise lh See $1,340 
DANK SLOCK 200. se. eee 1,100 2,440 


— $1,580 $1,580 





63 


The foregoing may be the “statement” the examiner had in mind. 
The only added information in this solution is afforded by the items of 
withdrawals, and this can not be accepted for anything more definite 
than the net results, as aggregate contributions and withdrawals would 
not necessarily show. 


Distribution of Capital Losses. 


In the distribution of profits and losses, no distinction is made be- 
tween those that arise through trading and those that result from the 
realization of capital assets. 

A partner’s capital may be extinguished from either trading or cap- 
ital losses and a deficit created that is made good from a copartner’s con- 
tributions, although, as in the case of S and T, before given, the deficit 
may arise from excessive drawings. 

After a full realization and liquidation, as an example, the following 
condition may be found to exist: 


Doe & Roe, Balance Sheet as at.......... 


i ee BE BOE NOG tod arbi al osm io ‘arnt capil $8,000 
Me ky Sale (a CANS a a a ap toner ge 2,000 


$10,000 $10,000 


In case the losses are divided equally, $2,600 would be chargeable to 
each of the partners, and this would bring about a condition as follows: 


Doe & Roe, Balance sheet as at.......... 


em LA St Se, GiSo6 © Dees Soe ET $5,400 
TP A a a Cae ae 600 
$5,400 $5,400 


The situation is that losses which were divisible equally have been 
incurred to an extent more than sufficient to extinguish Roe’s capital 
contribution and they overlap upon the capital contribution of Doe. 
Therefore, Doe would be entitled to receive the remaining cash, $4,800, 
and to collect from Roe the balance of $600 necessary to return to Doe 
his capital as shown to exist after the adjustment of the losses. 

A still more complicated condition would be the case of three part- 
ners, one capital account showing a deficit and the other two showing 
credits, and in which nothing could be collected from the partner with 
the deficit. The deficit, so far as the two responsible partners are con- 
cerned, is a loss, and should be borne in the proportion in which the profits 


64 


and losses were to be shared as between such partners. Thus, in the 
case of X, Y and Z, sharing profits and losses equally, the following con- 
dition existed: 


Gashouls Jn »sadoe ot » SPTGQOO. TDR, VS a $4,000 
Lie ere ake Ca ae BIOOO Nhe cir ace ait oth tee ee 6,200 


$10,200 $10,200 


Distributing the deficit of Z, which was uncollectible, equally be- 
tween X and Y, the following statement results: 
X, Y & Z, Balance Sheet as at.......... 


Cash 4. tial eee eee ate ce, $7200. ee eda $2,500 
AO Rr 4,700 
$7,200 $7,200 


The capital accounts, as adjusted above, disclose the proportions in 
which the remaining cash would be divided between the partners, X and Y. 
The adjustments of partnership interests under complicated conditions 
of this kind have given rise to many disputes and there are conflicting 
decisions. The foregoing, however, is the commonly accepted account- 
ing view. 
Interest. 


The capital contributions of partners are often unequal in amount. 
Therefore, the partnership agreement may provide for an adjustment to 
be made upon an interest basis, so that, before the division of the profits 
in the agreed proportions, an equalization is made that overcomes the 
inequalities of varying capital contributions. 

Such an adjustment, as commonly carried out, has no bearing what- 
ever upon the matter of profit or loss, but is merely an adjustment of 
the capital interests. | 

Thus, A, B and C contributed respectively $10,000, $5,000 and $5,000, 
to a business. The profits and losses were to be shared equally and each 
partner was to be credited with 6 per cent. interest upon his capital. 
Irrespective of profit or loss, to carry into effect the interest provision, it 
would be necessary to credit each partner with 6 per cent. interest upon 
his capital and to divide among the partners the aggregate interest in 
the proportion in which profits and losses would have to be divided. 

From this it will be seen that if capital is contributed in the same 
proportions as the profits or losses are to be shared, there would be no 


65 


need for a provision for interest upon capital. Thus, if the profits and 
losses in the case given were divisible respectively one-half to A, and one- 
fourth each to B and C, the interest procedure carried out and divided 
as to the debit in the proportion of one-half, one-fourth and one-fourth, 
respectively, the same result would be obtained. That is to say, the 
partnership interests would be exactly the same as though no calculation 
had been made. 

In the actual case, however, in which the profits and losses are divis- 
ible one-third to each partner, A receives 6 per cent. upon $10,000, amount- 
ing to $600 and is chargeable with only two-thirds thereof, so that his 
capital is increased $200 by the operation and the capital accounts of B 
and C are each decreased by $100. In this way, an adjustment is made 
that compensates A for his extra contribution of capital. 

The capital accounts would appear as under: 








Dr. A. Cr. 
Pre FOnt-te LOSS, 66... .>- SoG By Ganitalie edocs Waa $10,000 
MI cde ah stot «ane 10,200 “ Interest on Capital, 6%. 600 
$10,600 $10,600 

By Balanceyiiy) Js ves $10,200 

Dr B. Cr. 
Peer rou, eo LOSS. 666... PAOOMU AY ATIC La de ties e $5,000 
SenIanCe. 666 et 4,900 “ Interest on Capital, 6%. 300 
$5,300 $5,300 

Dy alatloc ec tenes ere tat ete $4,900 

Dr. C. Cr. 
memeeront & Loss......%... $4007 eBy Cantal amreersie soc. $5,000 
ee ANCE ee 4,900 ‘“ Interest on Capital, 6%. 300 
$5,300 $5,300 

BY A DAlAR Cera riick a dus sx $4,900 


In the ordinary case of profit earned, the matter of crediting interest 
takes the form of an appropriation of profit prior to the ordinary profit 
division, but inasmuch as the adjustment would take place irrespective of 
the securement of a profit, it is apparent that, after all, the procedure 
amounts to a mere adjustment and re-statement of capital interests to 


66 


carry into effect the provision to compensate, upon an interest basis, for 
unequal contributions of capital. 

In order to give full effect to equalization upon an interest basis it 
is necessary that interest should be charged upon drawings, so that the 
partner receives credit for the amount of capital that actually stands to 
his credit from time to time in the business. The interest may be cal- 
culated only upon an excess capital or charged upon a deficit. Thus, the 
agreement might provide that $10,000 of capital is to be contributed by 
each of two partners and that 6 per cent. interest is to be allowed on any 
excess capital or to be charged upon any deficit, that occurs. 

The credit or debit is carried to the capital account affected and the 
balancing portion of the entry is carried to an adjustment account or 
through the profit and loss account, to be divided as are profits and losses. 

The provisions that may be made for adjusting unequal contributions 
of capital or effort, either by the provision of so-called salaries, commis- 
sions, division of profit, etc., are innumerable, but they will be found 
to fall under the principles given. 

It will be plain to the student at this stage that the accounting prin- 
ciples involved are of general application, and the difficulties that are 
likely to be found in partnership accounting arise in the interpretation 
of the partnership agreements. 


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: ADVANCED THEORY AND PRACTICE 


OF ACCOUNTS. 
ORGANIZATION AND FINANCE 


By HOMER ST.CLAIR PACE, C. P. A. 
CORPORATIONS—LECTURE I. 


CORPORATE RECORDS. 


Dae ROMIREEPTORSHIP Se oe ugha UNL RN lal Seek: Faille ECL GN. I 
eG M ey ORME Re aN 2 
ORGANIZATION... .-.). ors eee uae EU Ms Ge cM ERA ALN GAM 3 

ee OME OU ech eee amet). Cake uP IU. ae Aw SOS As ale as Se rOa ce Aga 4 
OCR GAN BRCORDS O16 SU a twists tee Ser ee PONS papier 5 

Phang AND PRANGFERS OF STOCK 2105 os ye 6 
| Srock Boor. Ll Se GO MeN ay ee eg ELC RTA VG ea ore 1206 
DN Ey OO ar aha s 2 ed oes EAS ON ean a aa ei | 9 
: TRANSFER RECORDSIN LARGE CORPORATIONS O3k ae ee hn gare es II 
“Listinc Stock UPON STOCK PES OMAN Gu yOu ce i ond Ve es meet 


Peiiaee Or OTOCRHOLDERS Mio A Se os pee eis eee gL Ae 12 


COPYRIGHT, 1012, BY 
HomeErR St. Cratr Pace, 


Ey 


at 
» 


Ky 
pM tas a 





ADVANCED THEORY AND PRACTICE OF 


| ACCOUNTS. 
ORGANIZATION AND FINANCE 


By HOMER ST. CLAIR PACE, C, P. A, 
CORPORATIONS—LECTURE I. 


CORPORATE RECORDS. 


Proprietorship. 


Three distinct forms of proprietorship are employed in the invest- 
ment of capital and the organization and conduct of enterprises, viz.: 

1. Single Proprietorship, in which an individual, known as a sole 
trader, invests part or all of his capital and controls the undertaking; 
2. Partnership, the relation created by the association of two or 
more legally competent persons to carry on a lawful undertaking, in 
which they combine capital, skill or time, one or more of them, to achieve 
the purposes of the association; 

3. Corporate Proprietorship, the abtilrenects of capital by the crea- 
tion of an artificial being, as will be more fully explained later. 

The form of single proprietorship is the simplest and the one to which 
recourse is ordinarily first had in the natural development of an enterprise. 

The form of partnership is the outgrowth of the first form, through 
the economic desirability of combining capital and skill in the attainment 
of a mutual object. Thus, if the common object of A and B is to make a 
profit, to be attained through an undertaking in which both capital and 
skill can be advantageously employed, and A has skill but no capital, and 
B has capital but no skill, they can, by combining, produce more profit in 
the aggregate than would be possible if they should proceed independently. 

A partnership labors under the necessity for a dissolution of the form 
of organization in the case of the death of a partner, which may jeopard 
the business and capital invested.’ Further, individual liability for all 
the obligations of the undertaking attaches to each partner, thus placing 
his capital not invested in the particular enterprise subject to its vicissi- 
tudes. These conditions apply equally to a sole trader, and render desir- 
able the third form of proprietorship. 

Corporate proprietorship permits of the aggregation of capital, in 
many cases without further liability than the capital contributed, thus 
Copyright, 1912, by Homer St. Clair Pace. 


2 


enabling persons with small amounts of capital to contribute with limited 
liability and without actively assuming the responsibilities of manage- 
ment. It insures a continuity of the enterprise that is in nearly all cases 
desirable, and in some cases, as in a railroad, indispensable. The method 
is, therefore, from an economic viewpoint, the natural development of the 
partnership form, as the latter was of the single proprietorship form. 

The nature of the corporate form will be more fully apparent from 
the definitions and explanations to follow, although it is not intended, 
in this Lecture upon Theory of Accounts, to cover fully the legal prin- 
ciples involved. 

Definitions. 


A corporation may be defined as an artificial being created by law 
for certain specified purposes, composed of individuals united under a 
common name, the corporation being distinct from such individuals, so 
that it continues to exist notwithstanding changes in the individual mem- 
bers through death or otherwise. A corporation, for practically all pur- 
poses, is considered as a natural person. 

For accounting purposes, corporations may be considered in two 
general classes, viz.: 

1. Public corporations, organized for the purpose of government, 
such as a county or municipality. 

2. Private corporations, comprising (a) Stock corporations, or those 
organized for the purpose of profit, such as a mercantile, manufacturing, 
banking or railway corporation; (b) Non-stock corporations, organized 
for purposes other than profit, such as a cemetery, library or religious 
corporation. 

A stock corporation is defined to be a corporation having a capital 
stock divided into shares, and authorized by law to distribute to the holders 
thereof dividends or shares of the surplus profits of the corporation. 

There are certain distinctions to be observed in stock corporations. 
They may be divided into: 

1. Public Service corporations, or those rendering a public service 
for a private profit, with special powers or privileges, such as the right 
to condemn property, for the grant of which certain rights of supervision 
and control are reserved to the creating power. They are usually organ- 
ized under a general law, applying especially to the organization of such 
corporations and are subject to special restrictions. 

2. Business corporations, being the remainder of the stock corpora- 
tions. These are subject to a further division in some states. For example, 
in New York, financial institutions, such as banks and trust companies, 
are incorporated under a law applying especially to them. 


3 


The great majority of the stock corporations, however, consist of 
those organized for the purpose of carrying on trading and manufac- 
turing enterprises. 

Organization. 


The incorporation is usually effected under a state law, by the asso- 
ciation of natural persons, known as incorporators, who execute a certifi- 
cate of incorporation, in some states termed articles of incorporation, 
setting forth the name and object of the proposed corporation, its dura- 
tion, principal place of business, names of its first directors, the amount 
of its capital stock and its division into equal parts, known as shares, 
and such other matters as may be desirable or as may be required by 
statute, the incorporators specifying opposite their signatures the number 
of shares for which they respectively subscribe. When the certificate of 
incorporation is filed and accepted, and all the formalities have been 
complied with, the corporation is fully organized. 

The capital stock is divided into equal parts, known as shares, for 
the purpose of dividing the ownership of the capital. In New York, the 
shares cannot be less than $5, nor more than $100, each. Thus, if a corpora- 
tion has an authorized and issued capital of $100,000 divided into shares 
of $100 each, there would be 1,000 shares of stock, issued in the names of the 
various proprietors, known as stockholders, according to their ownership. 

Upon payment to the corporation of the par value of the shares sub- 
scribed by the original incorporators, certificates of stock are issued to the 
respective persons, certifying that the holder is the owner of a certain num- 
ber of shares of the capital stock of the corporation. The stock certificates 
are signed by the proper officers of the corporation, and, in New York, 
must be sealed with the corporate seal. 

The ordinary form of stock certificate is as follows: 


Incorporated under the Laws of the State of New York 
THE JOHN F. HOWARD COMPANY 


Capital Stock, $100,000 

RINE GLASER CESS) LILI ip ila n,m sale ie Lape wl ein ros loa vw sea lim Sua lee eb sies ihe is the owner of 
PUMReOy HUME WLU TIC ahs Sie Me ibeiale eh see Shares of the Capital Stock of 
THE JOHN F. HOWARD COMPANY, full paid and non-assessable, 
transferable only on the books of the Corporation by the holder hereof 
in person or by Attorney, upon surrender of this Certificate properly 
endorsed. 

(SEAL) 
IN WITNESS WHEREOF, the said Corporation has caused 

this Certificate to be signed by its duly authorized officers and to be 
mash with the Seal of the Corporation this...... Ce uOE eal Gia a's 
Jag BMT ge he 


Secretary. President. 


Shares $10 Each. 





4 


The following is an ordinary form of the stub bound in the stock 
certificate book against the certificate forms: 


Certificate NOW Gow aeccs 


bE ay a eR eh MIRA TRE ec BY Shares 
Tsetredfori. Wie ele oe eae 
DO BGET Je ic Aaleyal iets tatehon 1g 

Tsstied GO a ageieu lela Bias ierens 
Addressee y Cody SEN tee 


(Form of Certificate) 





The certificates may be sold and transferred, and for that purpose 
it is customary to print a blank power of attorney upon the back of the 
certificate. When this is properly signed by the stockholder in whose 
name the certificate is issued, the one to whom the stock is to be trans- 
ferred may personally, or by his attorney, transfer the stock to his name 
upon the books of the corporation. That is, he may surrender the old 
certificate for cancelation and receive in lieu thereof a new certificate 
issued in his name, thereby becoming a stockholder of record in lieu of 
the former stockholder. 

The following is an ordinary form of the assignment and power of 
attorney that appears on the back of a stock certificate: 


Sec eve rervieg€Cg€ ve bo ea Cee epee siesvwveenewVeseeh een es 02 ve 4 6 wv 2 6 + tb © % 6 0 @ 8 © SS Bie 8) Se eee eee 


Shares of the Capital Stock represented by the within Certificate, and do hereby 
irrevocably constitute and appoints.) 0.6 .ije 2 se oes ais wie + at piles » 5p 
» En nls brid ib un ale ARUP RAN Te eee ees aL my true and lawful attorney to transfer the said 
Stock on the books of the within named Corporation, with full power of substitution 
in the premises. 

Dated 2 toes eae ee ae ale 10. she 

In presence of: 


oS 0 0. eel bso se 2b 6)» eS.» 2 ales, b Bre seek ee mee te 


oo? 28 CA Peele ae GPS et aoe eCeevwes pee &@ oe o's © © 215 8 Oe eee 


Notice. The signature of this assignment must correspond with the name as 
written upon the face of the certificate, in every particular, without alteration or 
enlargement, or any change whatever. 





Control. 


The stockholders control the corporation through action taken at 
annual or special meetings. At such meetings a stockholder is ordinarily 
entitled to cast one vote for each share of stock standing in his name. 


5 


The immediate control is vested in the Board of Directors, the members of 
which are elected by the stockholders at the annual meeting of stockholders. 

The stockholders, or the directors when authorized by the stock- 
holders, adopt by-laws, which are rules providing for the calling of regular 
and special meetings of stockholders and directors, election of officers, 
duties of officers, and such other matters as may be desirable. 

The Board of Directors elects officers to manage the affairs of the 
corporation when the Board is not in session. The officers are subject 
to the Board of Directors in all matters, and their duties are prescribed 
in the by-laws. The officers, as ordinarily provided for, and their duties, are: 

President. The president is the chief executive officer of the corpora- 
tion, presiding at the meetings of stockholders and directors, and having 
general supervision of all its affairs. 

Vice=President. The vice-president performs the duties of the presi- 
dent in case of the latter’s inability to act, and such other duties as may 
be provided for in the by-laws. 
| Secretary. The secretary records the proceedings of the stockholders 
_ and directors at their meetings, has the custody of the seal of the corpora- 
tion, which he attests by his signature on certificates of stock, contracts, 
etc., and performs such other duties as may be required. 

Treasurer. The treasurer has charge of the receipt and disburse- 
ment of moneys, and in many cases it is his duty to keep the accounting 
records. 

There may be other officers, but in any event they will be elected 
and their compensation fixed by the Board of Directors, to which they 
are accountable. 


Books and Records. 


The books and records that are essential in the conduct of a corpora- 
tion, may be divided for convenience, into two general classes, viz.: 

1. Corporate Records. Under this will be grouped all books and 
records that are peculiar to the corporate form of organization, such as 
the Minute Book or Record Book, Stock Book or Stock Ledger, Stock Cer= 
tificate Book, and the Transfer Book. 

2. Financial Records. These records are intended to embrace the 
bookkeeping record of the financial transactions of the corporation, pre- 
ferably kept on the double-entry basis, which records do not necessarily 
differ from the accounting records kept in the other forms of proprietor- 
ship. They would consist of the Journal, Cash Book, Ledger, and similar 
books, and the books and records supplementary thereto. 

The first division is to receive particular attention in this Lecture, 
the detailed consideration of the second class being left for attention later. 


6 


Issues and Transfers of Stock. 


In close corporations, that is, ones in which the stock is held by a 
few persons, where the transfers of stock are apt to be rare, the original 
entry of the issue of a stock certificate usually consists of the entry on 
the stub, or counterfoil as it is sometimes called, of the stock certificate, 
the stubs and certificates ordinarily being bound in.a book. 

The stub is filled in with the number of the certificate, the date of 
issue, name of stockholder and number of shares, and the stockholder, 
upon receiving his certificate, receipts for it at the bottom of the stub. 

If the certificate is returned to the corporation for transfer to another, 
the assignment on the back is filled out with the name and address of the 
one to whom it is to be transferred and with the name of the attorney who 
will make the transfer on the books, and duly signed, the certificate is can- 
celed, generally by punching the signatures of the officers who signed it, 
and pasted back against the stub from which it was issued, and a new 
certificate is issued in lieu thereof, in accordance with the assignment, 
the new stockholder receipting for the new certificate on its stub. 

Thus, the stub and canceled certificate supply every detail essential 
to the record and for the posting to the Stock Book. 


Stock Book. 


In a stock corporation, the par value of the stock that has been issued 
is shown in the financial records in a single Ledger account known as a 
Capital Stock Account, no attempt being made to show the ownership 
of shares, this being done in a book or ledger known as a Stock Book or 
Stock Ledger. 

The New York law requires that a Stock Book shall be kept, setting 
forth in alphabetical order the names of the various stockholders, with 
their respective addresses, number of shares standing in the name of each, 
when they respectively became the owners thereof, and the amount paid 
thereon. The law requires that this book shall be open to the stockholders 
and judgment creditors of the corporation at least three hours of each 
business day. 

The Stock Book will, therefore, contain accounts in which are recorded 
the details of ownership of shares, equalling in the aggregate of par value 
the amount of the capital stock issued, as it is carried in a total sum in the 
Ledger belonging to the Financial Records. 

It is usual to keep the Stock Book as a double entry ledger, showing 
the total amount of shares of stock issued and outstanding in a single © 
account, which may be called Capital Stock Account, either as a debit 
or credit, it matters not which. This will show a balance of shares that 


7 
will equal, in par value, the balance of the Capital Stock Account in the 
Financial Ledger. On the contra side of the Stock Ledger, in proper 
accounts, appear the stock-holdings of the various stockholders, in shares, 
a separate account being given to each stockholder, the sum of the ac- 
counts equalling the total of the Capital Stock Account, thus establishing 
the valuable double entry check upon the accuracy of the book. 

It is more usual in the Stock Book to debit the various stockholders 
and run the Capital Stock Account with a credit balance. Although less 
usual, it seems more natural to credit each stockholder with his shares, 
keeping the Capital Stock Account with a debit balance, merely as a bal- 
ancing account, as it is more usual to think of a capital account, whether 
of shares or of an interest in a partnership, as a credit amount. It is 
quite immaterial, however, which form is adopted. 

The law requires that the number of shares, not dollars, shall be 
shown. This is better, regardless of the law, for the amounts are round, 
and keeping the record in shares saves many useless figures. 

The ruling of a Stock Ledger differs from that of the ordinary (ecioe 
On the extreme left of the page are columns for the month and day of the 
month, then a column for numbers of certificates issued, followed by a 
column for numbers of certificates canceled, although these two columns 
are sometimes combined and only one used. To the extreme right are 
three columns, one for debits, one for credits, and the third for carrying 
out the balance of the account, so that the requirement of the law that 
the number of shares outstanding in the name of each shall be shown, 
may ibe met, | 

To illustrate the use of the ruling, it will be assumed that J. W. Jones, 
of Tuxedo, N. Y., acquired 100 shares of stock of a corporation, and on 
January 2, 1902, certificate No. 115 was issued to him therefor. Later 
on February 8, 1902, he sold 50 shares of his stock to W. H. Lane, of 
White Plains, N. Y., and presented certificate No. 115 with the power 
of attorney on the back thereof duly made out, transferring 50 shares to 
W. H. Lane and the other 50 shares to be reissued to himself. 

In the first place, to record the acquisition of J. W. Jones of the 100 
shares of stock, an account would be opened in his name, and credited 
with the number of shares. If it were an original issue of stock, the bal- 
ancing Capital Stock Account would be debited; if it were a transfer, the 
account of the transfer would be debited. Upon surrender of certificate 
No. 115, it would be canceled by destroying the signatures by punching or 
otherwise, and would be pasted back against its stub in the stock certifi- 
cate book, and new certificates for 50 shares each would be issued in the 
names of J. W. Jones and W. H. Lane. In the account of J. W. Jones, 


8 


the cancelation of the entire certificate No. 115 must be shown, balanc- 
ing the account, and the new certificate, No. 125 for 50 shares, would 
be credited. An account is opened for W. H. Lane, as was done in the 
first instance for J. W. Jones. It is apparent that transfers do not affect 
the Capital Stock Account, which will be undisturbed, except in case of 
original issues of stock or reduction of outstanding stock, the latter being 
of rare occurrence. 
The procedure will be seen from the following illustration: 


J. W. JONES, Tuxedo, N. Y. 


Amount 
Date Gs rik Ott: Dr. Cr; Balance Paid 
Issued Canceled (shares) (dollars) 
I go 2 
Jan. 2 IIS I0o 100 Full Paid. 
Feb. 8 II5 100 ° 
ii 8 125 50 50 
W. H. LANE, White Plains, N. Y. 
Amount 
Date tf. Cté. Dr Cr. Balance | Paid 
Issued Canceled (shares) (dollars) 
1902 
Feb. 8 126 50 50 Full Paid. 





In addition to the columns shown in the foregoing rulings, columns 
are sometimes provided in which to enter the name of the transferee or 


9 


transferor, as the case may be. Thus, a column “from whom transferred”’ 
in the account of W. H. Lane would show from whom his stock was trans- 
ferred. This information however could be obtained from the stock 
certificate stub with small labor, were it required. 

In case of stock being only partly paid, it is necessary to provide 
a column to show the amounts actually paid in thereon from time to 
time. It may be placed to the extreme left of the page, or as shown in 
the foregoing. In case of fully paid stock it is not usual to enter the 
dollars in each case, a notation that it is fully paid being sufficient. 

It will be seen that the Stock Book ruling is not unlike the Journal 
ruling, except that an additional column is provided to show the balance 
of the account. This is not an unusual ruling in financial books, and 
is used by savings banks to show the balance of the customer’s account 
from day to day, or as often as there may be changes, and it is sometimes 
used as a ruling for the Customers’ Ledger in a mercantile business. 


Minute Book. 


It is necessary to keep a Minute Book, or Record Book, in which the 
proceedings of the meetings of the stockholders and directors are recorded. 
This record, in common with all other purely corporate records, is kept 
by the Secretary. 

If properly kept, the Minute Book furnishes a complete chronological 
record of the more important affairs of the corporation, including the 
election of directors, with their terms of office and compensation, if any, 
the by-laws as they are adopted and amended, the amount of capital 
stock authorized and issued, and the purposes to which its proceeds are 
devoted, the issuance of other securities, the adoption of contracts, elec- 
tion of officers and their terms and salaries, and the innumerable matters 
that are necessarily brought before the stockholders and directors for 
their formal approval. 

In recording the minutes of a meeting of the Board of Directors, 
the place and date of the meeting should be first stated, that the meet- 
ing was duly called in accordance with the by-laws, who presided at the 
meeting, and the names of the directors present, in order to show that a 
quorum, that is, the number necessary to transact business, was present. 

The by-laws usually specify how notice of meetings shall be given, 
but, as a general rule, it is better to state that the meeting was “duly 
called,’ than to attempt to specify the steps by which it was called If 
the latter is attempted, it must be done with great exactitude, or the 
record will itself show a defect. In the former case, in absence of proof 
to the contrary, it will be assumed that the meeting was properly called. 


Io 


Following the statement that the meeting was duly called is, ordi- 
narily, a statement that the minutes of the preceding meeting were read 
and approved. 

The business is generally transacted in the form of resolutions. A 
resolution covering a particular matter is presented by a director with 
a motion that it be adopted. The motion is supported by another director, 
and then presented by the presiding officer for discussion and vote. It 
is customary in the minutes to state the name of the director who presents, 
and the one who seconds, the motion, the resolution in full, and the fact 
of its adoption or rejection. In this way, the business transacted by the 
Board of Directors is recorded in the Minute Book. The record is ordi- 
narily signed by the Secretary and approved and countersigned by the 
President after its approval by the Board of Directors at a subsequent 
meeting, although in many corporations the Secretary alone signs the 
minutes. 

The same order of record is used for meetings of stockholders, which 
are ordinarily recorded in the same Minute Book, the records of the stock- 
holders’ and directors’ meetings appearing in the order in which they 
are held. The name of each stockholder in attendance at a stockholders 
meeting is recorded, with the number of shares of stock standing in each 
name, as well as a statement of the shares represented and voted by prox- 
ies, that is, persons authorized by power of attorney to vote stock stand- 
ing in the names of others. 

The Minute Book furnishes the best, and practically the only, record 
of the regularity of stock and bond issues, approval of contracts, and 
other important matters, and it is therefore highly important that it be 
properly kept. To the accountant, the Minute Book furnishes evidence 
of the correctness of many items of the Balance Sheet, and of salary and 
other expense items. An index of the Minute Book should be kept, in 
order that ready reference may be had to the resolutions. 

Whatever may be the merits of loose-leaf devices for certain lines 
of work, they should never be employed in any form for a Minute Book. 
The book should be substantially bound, preferably in full leather, and 
the minutes should be written in with a pen or with a book typewriter. 
Reliance in many cases must be placed on the record, and its form should 
be one that will, as nearly as possible, prove its authenticity on its face. 
Many cases are known, where the practice of writing minutes on a type- 
writer and binding them into a loose-leaf binder has been in vogue, in 
which the minutes of a meeting were taken out and destroyed in lieu 
of holding a meeting to rescind resolutions. This undesirable action 
would not occur were a proper form of Minute Book used. 


II 


Transfer Records in Large Corporations. 


In large corporations, where the stock is widely held and dealt in 
on the stock exchanges, a more elaborate system than heretofore described 
is necessary in order in insure accuracy in transferring stock and to facili- 
tate the tracing of particular transfers. | 

In addition to the Stock Ledger and Stock Certificate Book, a Trans- 
fer Journal is maintained. The book is opened flat and both pages are 
used for a transfer. On the left hand page are recorded the date, number 
of the transfer, name of the person from whom stock is received, number 
of certificate and number of shares, the latter appearing in a column to the 
extreme right of the left hand page. 

On the opposite, or right hand page, against the entry already out- 
lined, is recorded the name of the new stockholder, together with his 
address, the number of the new certificate and number of shares, the latter 
equalling the number received as per the entry opposite. 

If the stock is received from a number of holders to be transferred 
to one name, it is run under one transfer number; if, on the other hand, 
it is the stock of one person to be transferred into the names of several 
new holders, it is likewise covered by one entry. It will be noted that 
such a Transfer Journal merely arranges, in chronological order, the facts 
contained in the stubs and canceled certificates, and, in addition, gives 
to each transfer a distinctive number by which it may be traced. The 
number of the transfer, date, numbers of old and new certificates, number 
of shares, etc., are posted to the Stock Book or Ledger. 

In the case of an additional issue of stock by the corporation, it is 
entered on the left hand page as an original issue, to be posted to the 
balancing Capital Stock Account in the Stock Book, and on the right hand 
page the names of the new holders, numbers of certificates, etc., will be 
entered. In the case of different classes of stock, a separate ledger and 
transfer journal are usually kept for each class. 


Listing Stock upon Stock Exchange. 


Only such stocks and bonds as have been added to an official list 
kept by the Committee on Stock List are dealt in on the New York Stock 
Exchange. The Committee on Stock List requires that, before the securi- 
ties of a corporation are listed, it shall make a formal application, con- 
taining a statement of the organization and purpose of the corporation, 
its capitalization, the object of the new issue, and a balance sheet and 
statement of earnings, to be accompanied with copies of the charter or 
articles of incorporation, by-laws, stockholders’ and directors’ resolutions 
covering the issue, with any contracts or leases affecting the issue, all 


I2 


to be certified by an officer of the corporation. In this way an attempt 
is made to bar from the list questionable issues of securities. 

Certain rules have been adopted by the Stock Exchange as to what 
constitutes a “good delivery’’ of stock, that is, as to when the formalities 
of assignment, etc., have been met so that the purchaser must accept the 
certificate. These rules largely govern the action of the transfer offices 
of the large corporations in accepting stock for transfer. 

The Stock Exchange requires that bonds and certificates of stock 
must be printed from steel plates made by an engraving firm which they 
approve, so that no printed or lithographed certificates or bonds can be 
dealt in on the Exchange. | 


Lists of Stockholders. 


It is necessary to make lists of stockholders from the Stock Ledger 
for use at stockholders’ meetings and for dividend paying-purposes. In 
a small and closely held corporation this is a simple matter, but in the 
larger corporations, where the number of stockholders runs into the thou- 
sands, it is more difficult to prepare such lists at frequent intervals from 
large and clumsy ledgers. . 

It is not unusual for a corporation to have two or more classes of 
stock, and in making up a list it is difficult to sort out duplicates caused 
by the holding by the same person of more than one class of stock. It is, 
of course, desirable, in case of mailing notices of meeting, sending out 
annual reports, etc., to have a list of the actual holders of stock, without 
such duplication of names. 

The difficulty is obviated, and the labor involved in making a list for 
any purpose is reduced, by keeping a supplemental list of the stockholders 
on cards, each card giving the name of a shareholder, his address and the 
total number of shares, in lead pencil, of each class of stock standing in his 
name. These lead pencil totals are corrected from time to time as trans- 
fers are made, so that a list may be made at any time with the names of 
the stockholders in alphabetical order, with their respective addresses 
and holdings of stock, or envelopes may be addressed by running through 
the cards. The list, when completed, may then be checked against the 
Stock Ledgers. 

In fact, the entire record is sometimes kept in a card ledger without 
the use of the ordinary bound Stock Ledger, but this practice is the excep- 
tion rather than the rule. The use of loose-leaf ledgers has been found 
advantageous in the case of some of the largest corporations, the heavy 
labor incident to opening new ledgers thereby being avoided. 





a A ae 


Sa 
ens 
Oe Ma 





~ ADVANCED THEORY AND PRACTICE 


OF ACCOUNTS. | 
ORGANIZATION AND FINANCE 


By HOMER ST. CLAIR PACE, C. P. A. 
CORPORATIONS—LECTURE II. 


OPENING OF FINANCIAL RECORDS. 


ee eae RY tN lola kala, 33 
CONSIDERATION FOR Issur or STOCK.......... Ee ES ae Saceeeey 
Issuz or Stock ror Monry ONLY... .......0.0.., ee Gen Weenies r4 
Issup OF Parr OF AUTHORIZED STOCK FOR MONEY . PCRS AGS fee ater an 

an Desa OW PARTLY: PAID STOCK FOR MONEY: i ared oc 0 LENG hae 18 
MT INCORPORATORS.. 650s he cy ee ee i aa at 
IssuE OF STOcK FoR Property, Lazor DoNE AND MONEY........:. 21 

| ACQUISITION OP PuOvueniee 10 oi Se ee Le 24 


Corrective OPENING ENTRIES......... Fe DOU ROR IT ee ae eat 26 


COPYRIGHT, 1912, BY 
Homer’ St. CLAIR Pace. 





ADVANCED THEORY AND PRACTICE OF 


ACCOUNTS. 
ORGANIZATION AND FINANCE 


By TONE RST CATR PAC BH GP AY 
CORPORATIONS—LECTURE II. 
OPENING OF FINANCIAL RECORDS. 


In General. 

The principles of Double Entry bookkeeping are applicable to the 
accounting of any undertaking, irrespective of its form of organization. 
Double Entry has, in the past, found its most usual expression in single 
proprietorship and partnership accounting, and from this, perhaps, has 
arisen the erroneous idea that corporation accounting, as it is called, 
is a thing apart from bookkeeping and accounting in general, capable of 
being taught and practiced independently. 

It is a fact, however, that the accounting which has grown up with 
the general incorporation of business undertakings is but the development 
and adaptation of the double entry bookkeeping that answers so well the 
requirements of the other forms of business organization. 

It is, therefore, the study of the development and adaptation of 
Double Entry to the corporate form of organization that confronts the 
student, rather than the study of a subject involving new principles. 

The financial books themselves, so far as their names and general 
purposes are concerned, do not differ from those of a single proprietor- 
ship or a partnership. The Journal, Cash Book and Ledger are the three 
principal books. If a trading business is transacted, and the volume of 
transactions justifies, a Sales Book and Purchases Book, and, perhaps, a 
Returned Sales Book and a Returned Purchases Book are provided; the 
Cash Book will be amplified by additional columns, and the Ledger will 
be divided into a Customers’ Ledger, Creditors’ Ledger and General Ledger, 
and the first two ledgers will, perhaps, be further sub-divided. Bills 
Receivable and Bills Payable books may be used, and controlling accounts 
may be instituted to facilitate the taking of trial balances and to obtain 
the other benefits that come from their use. In other lines of enterprise, 
the books will present no unusual features on account of the corporate 


form of organization. 
Copyright, 1912, by Homer St. Clair Pace. 


14 


It will thus be seen that the financial books themselves present no 
unusual features, and the peculiarities of corporation accounting must 
be looked for in the method of recording certain transactions, particularly 
those relating to the contribution of capital and the payment of profits 
to stockholders, known as dividends. 


Consideration for Issue of Stock. 


The opening of corporation books is dependent to such an extent 
upon rules of law, that, although this is a Lecture upon Theory of Accounts 
rather than upon Law, it is necessary to quote, in full, Section 42 of the 
Stock Corporation Law of New York, which is a counterpart of the New 
Jersey law, and which states substantially the provisions of the law in 
many other states. It is as follows: 

‘“* Consideration for issue of stocks and bond.—No corpora- 
tion shall issue either stock or bonds except for money, labor 
done or property actually received for the use and lawful pur- 
poses of such corporation. Any corporation may purchase 
any property authorized by its certificate of incorporation, or 
necessary for the use and lawful purposes of such corporation, 
and may issue stock to the amount of the value thereof in pay- 
ment therefor, and the stock so issued shall be full paid stock 
and not liable to any further call, neither shall the holder thereof 
be liable for any further payment under any of the provisions of 
this act; and in the absence of fraud in the transaction the judg- 
ment of the directors as to the value of the property purchased 
shall be conclusive; and in all statements and reports of the cor- 
poration, by law required to be published or filed, this stock shall 
not be stated or reported as being issued for cash paid to the corpo- 
ration, but shall be reported as issued for property purchased.”’ 


It will be noted that the foregoing amounts, in effect, to a rule that 
the stock of a corporation cannot be sold at a discount, but must be ex- 
changed for cash at par, or for property or services that shall be worth, 
in the judgment of the directors, the par value of the stock issued therefor. 

The stock of a corporation may, therefore, be issued for one, or more, 
of the following items: 

1. Money; 

2. Labor done; 

3. Property. 


Issue of Stock for Money Only. 


The most simple state of affairs that could exist in the opening of 
corporation books of account would be the issuance of the total authorized 
capital stock for an amount of cash equal to its par value. 


a5 


The first actual bookkeeping record in such a case is made in the 
Corporate Records, heretofore described. Stock certificates are issued 
in the names of the incorporators for the shares for which they have 
respectively subscribed, upon payment to the corporation of their par 
value in cash. 

A Stock Ledger, or Stock Book, as the law terms it, is then opened, 
and from the detail contained in the stubs of the stock certificates, an 
account is opened with each stockholder, showing the number of shares 
issued in his name. A Capital Stock Account is opened to balance the 
individual accounts, which serves the double purpose of showing at any 
time the total amount of stock issued, and of providing the double entry 
check upon the accuracy of the Stock Ledger. 

The financial books proper are opened by a Journal entry, that should 
set forth, as a preliminary to the actual financial record, the name of the 
corporation, its object, capitalization, shares, with any other desired gen- 
eral information, and with the names of the incorporators and their respec- 
tive subscriptions for capital stock. A pro forma explanatory opening, 
with financial entry, to open the books of a corporation with an authorized 
capital stock of $100,000, all subscribed and paid for in cash, is as follows: 


THE JOHN F. HOWARD COMPANY 


A corporation organized under the laws of the State of New York, 
with an authorized Capital Stock of One Hundred Thousand Dollars 


—$100,000.00 


divided into One Thousand (1,000) shares of the par value of One 
Hundred Dollars ($100) each, with express and implied powers 
necessary to carry on the business of manufacturing a commercial 
substitute for ivory, said stock being subscribed as follows: 





Or Oe ELOW ATL. oa \l ss icla/ saa aya an 500 shares 

Porn es Howardy: [ros ye ae 200 

VV Mia RC TTAANE YS 0g a rudd sie tales FOO Mn ahs 

Pea PTA OOMAGES fs staly oe cite oth inne LOGI ine 

NAVE Ta Beart oe os cade naa Maat LOG? 
Cat watety, yes eyenatyale sa eee 1000 shares 


eS RAL ES CEOS oe a Ae Ss Wh alte bc Stn ae Sal eke eat PRN Pay $100,000 
‘ye Ge ALES TE el Oo OT CIE ge OR VN Bi $100 ,000 
For cash received in payment of stock subscribed as above, certifi- 
cates being issued, as under: 


MENTE RPOUTL EU ELOWALG 6s hloc yale od ow eselg wake eee 500 shares 
Cerro Wen oity Ler ER OWATC TEC) 34d) oleh adeect fal ate 200 

SEPM Otte WRC ASITINIGY a0 5 ee sin sis eae we es alm Wea san Sole lt bite 
PEN Ck Ae ALY FN MOUMETE A tealatutt ils whiels) ebluy diviacditace 100 f 
CPOE COS CONV pte VERE ate Gree, seh rsasasheh en vin aide Mayers Toc has 





ARS ATRIA EAU sO TONS Bec oT EO ME ORR AND | AYR rh 1ooo shares 


16 


If a Cash Book is to be maintained, the amount of cash is carried to 
the debit of the Cash Book; or, as is sometimes the case, the original 
entry for shares issued for cash may be passed through the Cash Book 
exclusively, although it is at all times satisfactory to have a complete 
record of the opening entries in the Journal. 

If there is no Cash Book, an unusual case, a Cash account is opened 
in the Ledger, to which the amount is posted from the Journal. Even 
though a Cash Book is maintained, a Ledger Cash account may be 
opened, and cash receipts and payments posted in summary form monthly. 

For the balancing posting, an account, under the caption of Capital 
Stock, is opened, to which is posted, in dollars, the amount of stock 
issued, thus completing the posting of the opening entry. 

No attempt is made, in the General Ledger, to show the distribution 
of the stock among stockholders as this is accomplished in the Stock - 
Ledger. 

The conversion of the cash, thus brought into the corporation, into 
the various assets necessary for the conduct of the business, is recorded 
along the usual lines of double entry bookkeeping. 

The Capital Stock, in some cases, is divided into classes. For example, 
there may be Preferred Stock, that, through a provision in the certificate 
of incorporation, may have a preference in dividends, that is, in the dis- 
tribution of profits, or a preference in the return of capital, upon dissolu- 
tion, or both, as well as Common Stock. Without an express provision, 
Preferred Stock will not have a preference in the return of capital in case 
of the liquidation, or winding up, of the corporation. 

In the case of there being more than one class of stock, an account 
will be opened in the General Ledger for each class, for example, Preferred 
Stock Account, to which the par value of all Preferred Stock issued is 
credited, and a Common Stock Account, to which the par value of all 
Common Stock issued is credited. 

In the event of there being only one class of stock, the term Capital 
Stock, and not Common Stock, is ordinarily used. It is Common Stock, 
of course, but the particular designation is not essential. 


Issue of Part of Authorized Stock for Money. 


There are two complicating contingencies that may occur in the 
opening of corporation books, even in a corporation in which it is not 
intended to issue stock except for cash, viz.: 

1. Issue of only a part of the authorized capital; 

2. Issue of partly paid stock. 


T7 


The first contingency is contemplated in Section 5 of the Business 
Corporations Law of New York, which is typical of the provision of many 
other states on this subject. It is as follows: 

“Payment of Capital Stock.—One-half of the capital stock 
of every such corporation shall be paid in within one year from 

its incorporation, or the corporation shall be dissolved, and the 

directors, within thirty days after such payment shall make a 

certificate of the fact of such payment, which shall be signed and 

acknowledged by a majority of the directors, and verified by the 
president or vice-president and secretary or treasurer, and filed in 

the offices where the certificates of incorporation are filed. The 

dissolution of any such corporation for any cause shall not take 

away or impair any remedy against it, its stockholders or officers, 

for any liabilities incurred previous to its dissolution.’ 


It will be seen from the statute quoted that a corporation may have 
an amount of authorized, but unissued, capital stock. It is not considered 
the best practice, text-book theories to the contrary notwithstanding, to 
carry into the financial books the amount of such authorized, but un- 
issued, stock. 

To illustrate, a corporation is organized with a total authorized cap- 
ital stock of $100,000, of which only $75,000 is issued, and for which the 
corporation receives $75,000 in cash. The remaining $25,000 is, therefore; 
authorized, but unissued, capital stock. 

To record properly the foregoing transactions an entry should be 
made, omitting the explanatory opening and entry explanation for brevity, 
as follows: 


DNS SA CAN Sel EA BW BLAS MB) C0) Gna nips SS AA abl He $75,000 


So far as the record of the $25,000 of authorized, but unissued, stock 
is concerned, this may be ascertained at any time from the Minute Book, 
as it will show the original capitalization and the issues of stock from 
time to time. 

In addition, the preliminary to the opening entry in the financial 
books, as already explained, will state the amount of authorized capital 
stock, and subsequent issues will appear in the financial books. 

The erroneous text-book method, to which reference has been made, 
is to debit Cash with $75,000, debit an account called Treasury Stock 
with $25,000, and credit Capital Stock with $100,000. This brings the 
unissued stock into the financial books, and encumbers the books with a 
useless $25,000 on each side of the accounts. If the additional $25,000 
of stock is ever issued, it will then be quite time enough to carry it into 
the financial books. 


18 


In England, it may be said, there is a provision of law that requires 
a corporation to show, in its published Balance Sheet, its total authorized 
capital. There is no such requirement in New York, and probably not 
in this country. 

Treasury Stock, properly so called, can only be created by the return 
to the corporation, through purchase or donation, of Capital Stock of the 
corporation that has theretofore been issued. In such cases a. Treasury 
Stock Account may be raised and charged with its value, actual or par, 
as the particular instance may require. It is apparent, therefore, that 
authorized, but unissued, capital stock, can not be treated as Treasury 
Stock. 

Issue of Partly Paid Stock for Money. 


The second complicating contingency arises from the practice of 
issuing partly paid stock. In New York, which will again furnish a typical 
example of the ordinary statute upon this subject. this is made possible 
by Section 62 of the Stock Corporation Law, as follows: 

** Partly paid Stock.—The original or the amended certificate 

of incorporation of any stock corporation may contain a pro- 

vision expressly authorizing the issue of the whole or any part 

of the capital stock as partly paid stock, subject to calls thereon 

until the whole thereof shall have been paid in. In such case, 

if in or upon the certificate issued to represent such stock, the 

amount paid thereon shall be specified, the holder thereof shall not 

be subject to any liability except for the payment to the corpora- . 

tion of the amount remaining unpaid upon such stock, and for the 

payment of indebtedness to employes pursuant to sections fifty- 
four and fifty-five of this chapter; and in any such case, the cor- 
poration may declare and may pay dividends upon the basis of 

the amount actually paid upon the respective shares of stock 

instead of upon the par value thereof.”’ 


This enables a corporation, by express provision in its certificate 
of incorporation, to issue partly paid stock. This privilege is subject 
to the provision of Section 5, of the Business Corporations Law, which 
has been quoted, that one-half of the capital stock shall be paid into the 
corporation within one year. In case of the issuance of such partly paid 
stock, the certificates are issued as usual, except that they should indicate 
upon their face that the stock is not fully paid. 

The vital point in accounting is that the corporation receives a cer- 
tain percentage of the capital, and the right to call for enough additional 
capital to equal, with the original amount paid in, the par value of the 
stock. When the difference is paid in, the corporation is bound to issue 
its fully paid certificates of stock. 


19 


Upon the basis of receiving cash and promises to pay in exchange 
for stock issued, the initial entry, whether carried out in the Journal, or 
partly in the Journal and partly in the Cash Book, in the case of a capital- 
ization of $100,000, payable 50 per cent. upon subscribing and the balance 
in monthly instalments of 10 per cent., would cover the following prin- 
ciples of debit and credit, viz.: 


oA SIR G2) ae OA Wate ar enue evoN et $50,000 
STOCKHOLDERS’ SUBSCRIPTION ACCOUNT _ 50,000 
POO PL DAN Dae LOC Kiaiex yan unen i gol lel Nib Ho $100,000 


To this entry should be added a suitable explanation, setting forth 
the names of the stockholders liable for further payments, with the respec- 
tive amounts. 

It more frequently happens, however, that the stock is not issued 
until it is fully paid, and in such cases the entry would be as follows: 


1ST a AS RURAL inet A nes $50,000 
STOCKHOLDERS’ SUBSCRIPTION ACCOUNT _ 50,000 
To SUBSCRIPTIONS TO CAPITAL STOCK $100,000 


As the payments are made, Cash would be debited and Stockholders’ 
Subscription Account credited. As the subscriptions are paid in full, 
stock would be issued, Subscriptions to Capital Stock being debited and 
Capital Stock credited. When all instalments are received and the stock 
issued, the Stockholders’ Subscription Account and Subscriptions to 
Capital Stock Account are closed out and Capital Stock Account stands 
credited with the entire issue of $100,000. The following entries illustrate 
the principles: 


To STOCKHOLDERS’ SUBSCRIPTION ACCOUNT......... 
See Mie PONS TO VWCAPTPAT pO NS a aaa hilar tede 
Veh (Mie 23 4 A IS @ WO aC a ape ssh ANU UT Rigs UOTE LR mPa Stet A? 


The only practical difficulty is that it is undesirable to maintain an 
account in the General Ledger with each stockholder, if such accounts 
are very numerous. They are of a temporary nature, and are no part of 
the trading operations of the undertaking, and yet it may become neces- 
sary at any time to know the exact amount due from an individual. 
Further, despite the fact that it may become necessary at any time to 
determine the status of an individual’s account, it is perhaps desirable 
to know the aggregate amount due more frequently than the status of 
particular accounts. . 


20 


In small corporations, individual ledger accounts are sometimes 
opened in the General Ledger, in lieu of a summary account, or perhaps 
more often, as outlined in the form of entry above, a summary account 
is opened under the caption of Stockholders’ Subscription Account, or 
other suitable name. Where the individual accounts are thus dispensed 
with, the amount due from any particular individual is arrived at from 
the explanations contained in the entries, or from the ledger account, if 
this information is carried, as it may be, to the detail columns of the ledger 
account. 

Where it is the intention to call in the balance due in instalments, 
the total amount may be divided into Instalment No. 1, Instalment No. 2, 
etc., and a ledger account opened for each instalment. The names of 
the subscribers may be entered in the explanation column on the debit 
side, filling in on the credit side opposite the names of the particular sub- 
scribers the payments as made. The names of those in default will thus 
not be credited and are easily ascertainable. 

The most satisfactory plan, especially where the stockholders are 
numerous, is to maintain the Stockholders’ Subscription Account in the 
General Ledger as a summary account, to which the total to be called is 
posted as a debit, and to which credits are made in periodical totals as 
amounts are paid in. 

A subsidiary ledger is opened, somewhat on the lines of a stock ledger, 

in which accounts are opened for the various stockholders, as per the 
explanation in the Journal entry, and a balancing account opened which 
corresponds to the summary account in the General Ledger. As pay- 
ments are made, they are entered in the Cash Book in a special column. 
The individual subscribers’ accounts are credited from day to day from 
the Cash Book, and at intervals, the Stockholders’ Subscription Account 
in the General Ledger is credited with total cash received, and the balancing 
account in the subsidiary ledger debited with the same total. Thus, from 
the subsidiary ledger, the state of any individual’s account may be deter- 
mined, and from the General Ledger, the total amount due may be ascer- 
tained when it is posted up to date. 
} This subsidiary account is sometimes maintained in the Stock Ledger, 
by providing in each stockholder’s account debit and credit money col- 
umns, charging the total amount, and crediting all payments made. The 
Stock Book must, in any event, show the amount paid by each stock- 
holder upon his subscription for stock, and combining the two economizes 
in effort. 

A still further amplification of the procedure in large corporations 
is to maintain a special cash register for recording receipts on account 


2I 


of stock subscriptions, carrying the receipts to the Cash Book in totals 
only, and posting directly to the individual accounts affected from the 
Cash Register. 


<< Dummy 4 Incorporators. 


It is sometimes desirable to have the incorporation effected by per- 
sons who are not the real parties in interest, known as “dummy’’ incor- 
porators. It is usual in such cases to have the certificate of incorpora- 
tion signed by the men selected, not less than three, usually for shares 
of the par value of $500, and it is customary for such incorporators to 
be named in the certificate as directors. 

The payments for the stock subscribed should actually be made, 
some corporation lawyers insisting that the payments be made by checks 
deposited in the bank by the corporation. The certificates are then issued 
to the incorporators, who assign them in blank and turn them over to the 
real parties in interest, who reimburse them for the cash paid in, if it was 
not, in fact, advanced in the first instance. 

If the incorporators are not to serve as directors, they will present 
their resignations and directors will be elected to fill the vacancies, and 
the stock assigned by them will be transferred to the real owners. If 
they are to act as directors, and the holding of stock is a necessary qualifi- 
cation, the assigned certificates will be held assigned in blank, so that the 
directors will be stockholders of record, although they will not, as a matter 
of fact, own any stock. 

So far as the accounting is concerned, it must be ascertained that 
the corporation received value equal, in the judgment of the Board of 
Directors, to the par of the stock subscribed, and that the certificates 
were actually issued. Cases are frequently found in which the stock is 
subscribed by “dummies’’ but issued in the first instance to the parties 
in interest, with no assignment. This is a serious defect that must be 
remedied by counsel, and is a condition that the accountant should not 
display in the books. 


Issue of Stock for Property, Labor Done and Money. 


In the organization of a corporation, even where the bulk of the 
stock is to be issued in exchange for property, it is quite usual for a few 
shares to be subscribed and paid in cash, say five shares of $100 each, 
although it is not an essential that any part of the capital be paid in cash. 
The organization may be thus effected so long as the capital with which 
the corporation begins business is not less than $500, and so long as one- 
half of the authorized capital is paid in within one year. 


22 


Stock is also sometimes issued to pay for legal and other. expenses 
incurred in promoting and organizing the corporation. 

It will, therefore, happen that, except in the case where the shares 
are paid in cash only, the corporation will receive two, and sometimes 
three, of the items that may be received in exchange for stock. 

To illustrate, a corporation may be organized with an authorized 
capital of $10,000, of which ten shares of $100 each, $1,000 par value, are 
to be issued for cash, and 70 shares, $7,000 par value, are to be issued for 
the property of a partnership which is fairly worth, at market prices, the 
$7,000 thus to be paid for it. 

The opening entry, if passed entirely through the Journal, and the 
issue of stock for Cash and for Plant and Sundry Assets is simultaneous, 
might properly be as follows: 


OFT BARR ar nen Arie Way RRNA eR bol TARE. ors! $1,000 
PLANT & SUNDRY sASSETS iicpatace ee on cl 7,000 
To CAPITAL STOGE ay ie Oa es eas $8,000 


The item of Plant & Sundry Assets might be divided into the dif- 
ferent asset accounts, such as Plant, Merchandise, and Accounts Receivable, 
in the initial entry, as is the custom with English accountants. In Amer- 
ican practice, however, it is usually entered in the first instance by a charge 
to Plant & Sundry Assets, to be distributed later to appropriate property 
accounts under captions and values authorized by the Board of Directors 
of the corporation. In this way the responsibility for fixing the values is 
placed where it belongs, and the opening may be carried out without delay. 

No account is taken in the financial books of the amount of author- 
ized, but unissued, stock, being 20 shares, $2,000 par value, for the rea- 
sons given in considering a similar case in the disposition of stock for 
cash only. 

It need hardly be stated that the above entry should be preceded by 
a resumé of the principal facts of capitalization, business, etc., embodied 
in the certificate of incorporation, as was suggested in the first example 
of opening corporation books. It will hereafter be taken for granted 
that the student understands that the entry should be preceded by such 
an explanation; that the authorized, but unissued, stock is not to be 
carried into the financial books; and that the cash part of the entry may 
be made in the Journal, to be posted to the Cash Book, or passed through 
the Cash Book exclusively. 

Continuing the illustration just given, it will be assumed that the 
same state of facts exists with the exception that the vendors require 
that $8,500, in stock, shall be paid for the property that is to be turned 


a 


over, instead of the amount $7,000, which would equal the market value 
of the tangible assets. 

The vendors may base their claim for this larger amount on the 
ground that there is good-will to be taken into consideration, or that 
the stock which they are to receive is not readily marketable, and would 
have to be sold, if at all, under a discount. At any rate, vendors usually 
require, in exchange for the property and good-will of a going concern, 
an amount of stock the par value of which considerably exceeds the mar- 
ket value of the net assets. 

It will be further assumed that $500 of stock is issued on account of 
labor and services in organizing the corporation. 

These various items will necessitate the issue of the entire authorized 
capital stock, as appears from the following entry: 


ePIC UI ls Ab $1,000 
Beit cr OUN DRY “ASSHT Saheim, line 8,500 
Sra NIZATION HXPENOH Sie fe vene sak 500 
OD G IN E L AL, io LOG Keane ea as 28 Veen Yoko $10,000 


In practice, the acquisition of Cash and of Plant & Sundry Assets, 
and the incurrence of Organization Expenses, might not be simultaneous; 
in which case a single entry would not include the entire transactions, 
each transaction being recorded as it occurred. In the illustrations, for 
the sake of brevity in setting forth principles, they are treated as one 
transaction. s 

Later, when values have been placed upon the different assets by the 
board of directors, the necessary asset accounts are raised and charged, 
including, if necessary, a Good-Will account, and the Plant & Sundry 
Assets account is closed. 

Assuming that the Plant was valued at $5,000, Stock on hand $1,000, 
Accounts Receivable $1,000 and Good-Will $1,500, such an entry would 
be as follows: 


Rr Mere eet er Sy ka SAY PR Stan nya giars are $5,000 
MME IN TAIL ee lg acc og St aaltehababe tet die Crane tare 1,000 
POU NM bo CE LV A BiB oie isan camera a T,000 
Pe VV RE, Daim MOh SUDA SUE TAR et I, 500 
TOM AN Desa SUNDRY) ASSE DON Oee Sunn $8, 500 


Organization Expenses Account is frequently allowed to stand, to be 
written off out of profits during the first few years, say three, of the under- 
taking, instead of charging the entire amount against the profits of the 


24 


first year. A less conservative practice is to charge the amount to the 
cost of property. . 

The above problem may be solved in a slightly different way, by 
charging Plant & Sundry Assets in a separate entry with the $8,500 and 
crediting the Vendor. Later, when stock is issued to the Vendor in settle- 
ment, his account is closed by a charge, and Capital Stock Account is 
credited for the amount issued. 

This method is especially advantageous when the taking over of the 
assets and issuing stock therefor are not simultaneous, and in cases where 
liabilities are assumed as well as assets taken over. 

Thus, in a case where the assets are carried on the books of the vendor 
at $9,000, and the liabilities assumed amount to $2,000, and the agree- 
ment is that the vendor shall receive $8,500 in stock for this net equity of 
$7,000, the entry would be as follows: 


PLANT: & SUNDRY (ASSETS) enim Wuiaay $10, 500 
To' SUNDRY. LIABILITIES MGR eo | $2,000 
To BLANKS) Vendors. ta ae ee ee 8,500 


The Plant & Sundry Assets Account, and Sundry Liabilities Account, 
would later be distributed into specific accounts in pursuance of the action 
and direction of the Board of Directors. 

A slightly different way to record this transaction would be as 
follows: 


PLANT (@ SUNDRY ASSETS tea one $10,500 

To (BILAN Ks) Vendor ( 2Oo0pe eee i eae | $10, 500 
BLANK: "Venton Soe ee a see 2,000 

lo SUNDRY LIABILIDT ES aeons eee 2,000 


It will be seen that this is practically the same as the preceding method, 
although it may be contended that there was never a moment of time at 
which the real liability to the vendor was $10,500, as shown momentarily 
by the first entry. The distribution into the particular asset and liability 
accounts would be made later. 


Acquisition of Properties. 


In the case of the purchase of a going concern, the contract of pur- 
chase will specify a date at which the transfer is deemed to have taken 
place, or a date at which it is to take place. This date becomes the account- 
ing dividing line between profits, those accruing before that date belonging 
to the vendor, and those accruing subsequently belonging to the vendee. 


25 


) 


The line of demarcation must be sharply drawn and care exercised to make 
the apportionment in accordance with the principle stated. 

If the vendor continues to hold and operate the property, he does 
so for the account of the vendee, and must turn over to the vendee the 
profits earned, although entitled to compensation, no doubt, for services 
rendered. | 

If a period of time elapses between the date agreed upon as the time 
at which an enterprise is to be turned over, and the actual organization 
of the buying corporation, any profits earned should be treated as a 
diminution of the purchase price. Likewise, expenses incurred may be 
capitalized and added to the cost of the property. Otherwise, the cor- 
poration would be in the untenable position of earning a revenue or in- 
curring a loss before its existence and starting operation with a balance 
of profit or loss. 

The corporation can not make a contract before it is organized, but 
the contract of purchase is often made by the promotors of the corpora- 
_tion, who assign the contract and all equities thereunder, in consideration 
of a certain amount of the stock or other securities of the new corpora- 
tion. The net asset value acquired under the contract is the amount 
that must be set up in offset to the securities issued in payment, and 
technical profits, earned before actual possession is acquired, must be 
merged in such net asset value. 

For example, the business of a partnership with a capital of $100,000 
was to be taken over as at January 2, 1902, in consideration of an issue 
of $100,000 of the stock of a corporation, and the business was not actually 
taken over until January 23, 1902. During the three weeks the capital 
increased, after paying all expenses and charges, to the extent of $1,750, 
through profits secured. The $1,750 can not be carried into the accounts 
of the corporation as a profit, but must be merged in the cost of the prop- 
erties acquired, the net asset value of which must be stated at $100,000 
and not at $101,750. The amount would preferably first be applied to 
writing down such intangible assets as good-will or patents, and then to 
such assets as plant and machinery. If it were not advisable to write 
the assets down, a special reserve for depreciation or loss could be credited 
so long as it is clearly shown that it is not a profit. An asset should be 
taken into the accounts at its cost, and if a profit should be shown in such 
a case, it would be taken in at an amount in excess of its cost. 

Inversely, if a mortgage were made and bonds issued thereunder dur- 
ing the process of acquiring the properties, any interest thereon before 
actual trading or operations began would be a charge against the cost 
of property, because it is a necessary incident to such acquisition. That 


26 


is, such interest charge is not incurred as a part of the cost of securing 
profits through operation, but as a part of the cost of securing the neces- 
sary equipment with which to operate. Were it otherwise, the corpora- 
tion would begin to operate with a loss upon its books. If, as a matter ' 
of conservative business policy, it is decided not to capitalize, that is 
carry to the cost of the property, such interest, a charge therefor may 
be made against the first year’s profits, when secured, in such a way that 
the results of operation or trading will not be obscured, and the property 
written down with the amount. 


Corrective Opening Entries. 


It is not unusual to find instances in which corporate accounts have 
been imperfectly opened, or not opened at all. The corrective work 
necessary will depend upon the circumstances of the specific case. 

In the case of a corporation organized to originate a business, it is 
not infrequent to find that the amount of cash actually received is charged 
to a Cash account and the amount credited to an account called Stock 
Receipts account, or some similar name. In other cases, it may happen 
that no method of accounting is attempted further than the keeping of 
a Minute Book, a Check Book, and an account with the bank. In still 
other cases, especially where the corporation is organized to take over 
the business of a partnership, the attempt may be made to maintain an 
account with each stockholder, showing the amount of stock in his name, 
somewhat after the manner of keeping capital accounts in a partnership. 
The most chaotic condition that is likely to be found is an absence of a 
knowledge of the assets owned and liabilities incurred, and the absence 
of an adequate record from which such facts may be ascertained. 

-No matter in how imperfect a condition the accounts may be found, 
there are certain points that must be established in order to bring the 
books to a condition where they will disclose the facts as to financial posi- 
tion. The process, in case no accounts have been kept, is to prepare a 
financial statement, along the lines of a balance sheet, carrying the assets 
to the left, and the liabilities and capital stock to the right, in opposition 
thereto. | 

To begin with, the amount of the capital stock issued and outstand- 
ing, if regularly authorized, can be ascertained from an inspection of 
the Minute Book, care being taken that no greater amount of stock is 
issued than is authorized by the certificate of incorporation and the reso- 
lutions of the stockholders and directors. The authority for stock issues 
being established in the Minute Book, an inspection of the Stock Certifi- 
cate Book, if it has been properly kept, will disclose the certificates that 


27 


have been issued, the names of the holders thereof, and the number of 
shares for which each is drawn. The par value of the stock that is found 
to be authorized, issued and outstanding, should be carried to the right 
side of the financial statement, and provides the starting point in the 
construction of a statement to display the financial position of the corpo- 
ration. At this stage it should be determined that a Stock Book has 
been kept, containing, in alphabetical order, accounts showing the stock 
holdings, in accordance with the statutory provision that has been cited 
in a previous Lecture. 

The liabilities, with the aid of the creditors, may often be determined 
without difficulty, and should be listed and displayed on the right side of 
the statement in conjunction with the capital stock. The amounts of 
capital stock and liabilities are determined first on account of the ease 
with which they may, in the majority of cases, be established. 

The assets should be inventoried, and such items as Real Estate, 
Plant, Machinery, and other permanent assets, carried into the left side 
of the statement, in opposition to the capital stock and liabilities, at their 
cost, if such cost can be ascertained; if not, at an appraised value to be 
obtained from the best authority available. If any of the assets were 
acquired in exchange for issues of stock, the transaction will, in all prob- 
ability, be disclosed by an inspection of the Minute Book, and the assets 
should be stated at their cost in par value of the stock issued therefor, 
irrespective of market, or other, values. Care should be taken that all 
assets are inventoried and brought into the statement. 

After all of the issued and outstanding capital stock, and all of the 
liabilities, of the undertaking, have been displayed on the right side of 
the statement, and all of the asset values have been carried into the state- 
ment on the opposite, or left, side, the statement should be brought to a 
balance by a Profit and Loss Account. If the assets exceed the combined 
amount of capital stock and liabilities, a profit exists in the business, and 
should be displayed by a Profit and Loss Account credit balance. If, on 
the other hand, the combined capital and liabilities exceed the amount of 
the total assets displayed, a loss exists, that should be displayed by a 
Profit and Loss Account debit balance. 

Provided that all of the assets, capital stock and liabilities have been 
taken into the statement, the Profit and Loss Account will invariably 
show the correct result as to profit or loss. This is true, because, in the 
first instance, the asset value received by the corporation will exactly — 
equal the amount of capital stock issued. If, aside from the original con- 
tribution of capital, assets and liabilities were acquired and incurred that 
exactly equaled each other, there would be no profit or loss; but, if the 


28 


assets acquired exceeded the amount of the liabilities incurred, a profit 
would exist. Inversely, if the liabilities incurred exceeded the amount of 
assets acquired, a loss would exist, and in either case the balance would 
be effected, and the true condition shown, by bringing the Profit and 
Loss Account into the Statement. 

With the statement prepared, as a basis, a Journal entry is passed 
debiting the assets and crediting the liabilities and Capital Stock, accounts 
in the Ledger are opened to conform, and the postings are made. The 
books being thus opened, the succeeding transactions are recorded in 
due course. 

In case the record has been kept as in a partnership, or some other 
systematic attempt at a complete record, the books of the corporation 
may be opened by a Journal entry stating the original position as to assets 
acquired, liabilities incurred, if any, and stock issued. The subsequent 
transactions may be brought into the accounts by a summary entry, 
carrying in the balances of the nominal accounts, as well as amounts suf- 
ficient to adjust the other accounts to their proper amounts as shown 
by the trial balance of the books kept on the partnership or other basis. 








ADVANCED THEORY AND PRACTICE 


OF ACCOUNTS. 
ORGANIZATION AND FINANCE. 


By HOMER Sr. CLAIR PACE, C. P. A. (N. Y.) 
CORPORATIONS—LECTURE III. 


CLASSIFICATION OF ASSETS AND LIABILITIES. 


CAPITAL ASSETS AND CURRENT ASSETS.........0.50200 2 bese eee eee 29 
CaPpiTAL LIABILITIES AND CURRENT LIABILITIES...........-.25.-4--. 31 
RRR ice Oe? ase ee ea 8 SB a OR oe Poe ne oe ae 34 
MMIIEIRS WADITAN. ho po fois a8 ER Gales Botte ie sae te A al 8 35 
a EMPATION 20 rN) RNs SS e Ns SE tk ty een OE ee ga 37 
SeeecTPATiVe DALANCE SHER. . 43200 o-5.5 2 ee a he ees oe See 38 


COPYRIGHT, I912, BY 
Homer St. Crair Pace. 


eR ahr ae 
wes » 


Pech 


hy Oe 
ey ay 
4 PeAEB. ¢ 





ADVANCED THEORY AND PRACTICE OF 


ACCOUNTS. 
ORGANIZATION AND FINANCE 


Be ROME Ras CLAIR PACH. CP. AU (N. Y.) 
CORPORATIONS—LECTURE III. 
CLASSIFICATION OF ASSETS AND LIABILITIES. 


Capital Assets and Current Assets. 


A part of the capital of an organization, corporate or otherwise, in 
the ordinary course, will be required for investment in assets that will 
be held for the permanent use of the enterprise, such as lands, buildings, 
machinery, and fixtures. The remainder of the capital will be required 
to finance the current operations by the purchase of such items as mer- 
chandise, raw materials and supplies, and the payment of salaries and 
wages, pending the returns of the business. 

Thus, in a manufacturing corporation, organized with a paid-in 
cash capital of $100,000, the permanent plant might require the expendi- 
ture of $80,000 of the capital, leaving a balance of cash, not expended on 
the permanent plant, of $20,000. It will be obvious that some amount 
of cash should be left over, after the purchase of the real estate, plant 
and other equipment necessary to carry on the manufacturing operations, 
for such a plant cannot be run without the purchase of raw materials 
and supplies, and the payment of labor, the returns for which will be 
delayed through the time consumed in manufacturing the product, mar- 
keting it, and collecting therefor. 

The assets thus invested,,or sunk, permanently in the undertaking 
are known as Capital Assets, sometimes called Permanent Assets or Fixed 
Assets. In the construction of a Balance Sheet to display the financial 
condition of a corporation, or of any organization of considerable size, 
it is customary to group such assets under the caption of Capital Assets, 
as a first division on the asset side of the Balance Sheet, listing the assets 


and carrying out the total. 
Copyright, 1912, by Homer St. Clair Pace. 


30 


In addition to permanent investments in land, buildings, machinery 
and similar assets, investments may be made in the securities of other 
companies engaged in similar lines of business. When it is the intent 
to invest the capital permanently in such securities, it is convenient to 
state them as Investments in Other Companies, as a division of the Capital 
Assets. It is often expedient, however, to make a separate classification 
of such assets, not including them in the Capital Assets, but stating them 
as a distinct classification immediately after the Capital Assets. If minority 
interests only are owned in such companies, the shares may be considered 
a temporary, rather than a permanent, investment of the capital, and, 
in addition, a company may be liquidated and the investment returned 
without the power on the part of the owner of the minority shares to 
prevent such action. In the case of companies controlled by the owner- 
ship of all, or a majority, of the shares of stock outstanding, the best 
method is to present the actual assets and liabilities of the companies 
in a Consolidated Balance Sheet, with the stockholdings eliminated, as 
will be explained later. 

As distinguished from the Capital Assets, those that are held in realized 
form, such as cash, or are held merely for the purpose of realization, such 
as raw material, inventory, bills receivable and accounts receivable, are 
known as Current Assets, sometimes called Quick Assets, Floating Assets, 
or Liquid Assets. The term Cash Assets, sometimes used to designate 
Current Assets, is apt to be misleading, and is therefore a less desirable 
term. The Current Assets are listed under that caption below the Capital 
Assets, and the total is carried out under the total amount of the Capital 
Assets. 

The Current Assets, strictly, are those in realized form or those held 
only for realization. In the case of amounts that stand to the debit of 
ledger accounts that represent a transient benefit or favorable effect upon 
the business, to be received in a future period, such as advertising paid 
for in a period before its effect is enjoyed, a deferred charge to profit and 
loss exists, although it stands, for the moment, as a nominal asset upon 
the books. Evidently, such Deferred Charges are not Capital Assets, 
and, not being held for realization, are not Current Assets, even though 
some value might be recovered, as in the case of prepaid insurance. It 
is best to segregate such items from the Current Assets, and list them 
under the caption of Deferred Charges in a final division on the asset side 
of the Balance Sheet. 

An accrued asset is one that has accrued, but is not due, such as 
interest that has accumulated upon a bond, but that does not become 
collectible until a subsequent date. Accrued assets are, in the accounts 


ar 
of some corporations, classed as Deferred Assets, on the theory, appar- 
ently, that they constitute a distinct class. This is not justified by the 
facts, because the amount of a note due to be paid to the company in 
three months, classed as a Current Asset, is analogous to an amount of 
accrued interest that will likewise be due to be paid in three months. 
Such an asset should, therefore, be classed as a Current Asset. 

A wasting asset is one that is consumed with the progress of the busi- 
ness or the effluxion of time. For example, a mine contains an aggre- 
gate amount of mineral, and every ton taken out during the progress 
of the work diminishes to that extent the amount available. Its wast- 
ing does not depend upon the effluxion of time, but upon the actual mining 
operations. When the mine is entirely worked out, its value is extin- 
guished, and even the machinery and appliances, in such a case, would 
have little or no residual value. If it is desired to keep the capital of 
the corporation intact, that part of the proceeds of each ton that repre- 
sents the capital cost must be retained and not distributed in dividends. 
It is quite usual, however, to distribute the capital invested in the mine 
with the profits, mining companies forming the exception to the rule 
that capital cannot be returned to the stockholders in the guise of divi- 
dends. An example of a wasting asset that depreciates with the effluxion 
of time, regardless of use, is a prepaid lease of land for a term of years. 
In fact, any asset that wastes through use or the effluxion of time may 
be said to be a wasting asset, and is properly classified as a Capital Asset. 
It should be carried at the amount of the value remaining, estimated 
conservatively on the basis of the best data obtainable. 

Assets enter mains are defined to be assets in hand, such as the prop- 
erty that comes into the possession of an executor or trustee for the 
purpose of meeting the immediate claims against the estate in his charge. 
The use of the term is rare except in the transactions of executors or 
trustees. 

In law, the term legal assets denotes those that constitute a fund 
for the payment of debts accrued at their legal maturity, and equitable 
assets are those that can be obtained only through an action in an equity 
court. These terms are not used in the Balance Sheet classifications. 


Capital Liabilities and Current Liabilities. 


In the conduct of an enterprise, it may be desirable or necessary to 
incur financial liabilities through the purchase of merchandise, materials 
and other property on credit, by the borrowing of money upon promissory 
note or bond, or through one of the many other channels that present 
themselves in the regular course of trading or operating. 


32 


The financial liabilities thus incurred are classified, as a general rule, 
according to the length of time for which they run. The long-time lia- 
bilities, such as an issue of bonds secured by mortgage upon real estate 
and plant, and the other liabilities the maturity of which extends beyond 
a certain length of time, are known as Capital Liabilities, sometimes called. 
Permanent Liabilities or Fixed Liabilities. 

In addition to the long-time liabilities, it is customary, in the case 
of a corporation, to include Capital Stock in the Capital Liabilities. Cap- 
ital stock is not a liability, and does not fall due to be paid at any time 
or in any amount. It represents ownership merely, divided into share 
units, and, plus any credit for profit or surplus undisturbed, or less any 
loss incurred, it measures the book value of the investment to the owners. 
Its inclusion, therefore, with Capital Liabilities, however, customary asso- 
ciates unrelated elements. The total, however, is an amount of capital 
that, under usual conditions, will remain in the business, and need not 
be met from current assets. 

The Capital Liabilities are listed and stated as the first group on 
the right side of the Balance Sheet, the total amount being carried out. 
The Capital Liabilities are thus displayed in opposition to the Capital 
Assets, although there is not necessarily any close relation as to amount. 
The classifications are as to character of assets and liabilities, and the 
character of both changes as business expediency requires their change 
from one to another. 

The short-time lhabilities, such as accounts payable, and bills and 
notes that fall due within a certain time limit, are known as Current Lia= 
bilities, sometimes called Quick Liabilities or Floating Liabilities. Current 
Liabilities are listed on the Balance Sheet under the caption Current 
Liabilities, and the total amount carried out under the total amount 
of Capital Liabilities. This displays the Current Liabilities in opposi- 
tion to the Current Assets, and a comparison of the respective totals 
affords one of the most valuable guides as to ability of the undertaking 
to meet its immediate liabilities. 

The distinction between Capital Liabilities and Current Liabilities 
rests solely upon time of maturity. A fifty-year bond, or even a ten- 
year bond, will be classed immediately as a Capital Liability, and a sixty- 
day note as a Current Liability. Between the two lies the line of demarca- 
tion, and its exact location will depend upon the nature of the business. 
It may be, in many instances, that all liabilities that fall due within the 
period of time for which banks discount commercial paper should be 
classed as Current, and those that extend beyond that period as Capital. 


33 


If a Capital Liability, by the effluxion of time, comes within the 
limit, it is truly a Current Liability, although it might be unusual so to 
class it, for it must be paid or renewed. This is obvious when it is remem- 
bered that the object of the classification of Current Liabilities is to state 
for ready reference the liabilities that must be paid or renewed within 
a certain time. A Capital Liability that cannot be renewed becomes 
as much a Current Liability as a short-time note that is due and cannot 
be renewed, and merely because Capital Liabilities most frequently dre 
renewed does not change the theoretical classification. 

The attempt is sometimes made to classify the liabilities on the basis 
of the use of their proceeds, the theory being advanced that Capital Lia- 
bilities produce Capital Assets. The error of this is plain in the case of 
a corporation, with a paid-in capital of $100,000, invested in plant, that 
finds it necessary to mortgage its plant to secure $25,000 of funds for 
the purchase of Current Assets, or for the liquidation of liabilities incurred 
through the purchase of such assets. The liability would be classed, if 
it secured a long-time loan, as a Capital Liability notwithstanding the 
fact that the proceeds were used to provide Current Assets. The fact 
is, the conversion of assets from one form to another is a matter of busi- 
ness expediency, and, subject to mortgage conditions, is made regardless 
of form or time of liabilities. The proceeds might even be lost, in whole 
or in part, without changing the nature or the amount of the obligation. 

The payment of Capital Liabilities is usually secured in some formal 
way, as by mortgage on real estate and other property. The aggregate 
of such liabilities is known as Funded Debt, from the custom of funding 
short-time obligations into long-time bonds or notes, secured by mortgage 
or other indenture. The interest, definite in amount, and recurring regu- 
larly, is known as Fixed Charges. In railroad accounting, rentals under 
long-time leases of property, and sometimes taxes, are included in Fixed 
Charges. 

An accrued liability is one that has accumulated, but is not due to» 
be paid. Such a liability is properly classified as a Current Liability. The 
distinct classification of Deferred Liabilities is undesirable for the reason | 
given for excluding Accrued Assets from the classification of Deferred 
Assets. 

A contingent liability, as the term indicates, is one that may, or may 
not, become an actual liability, definite in amount. A contingent liability 
arises in the endorsement of a note or bill discounted, unless liability 
is specifically avoided by the form of endorsement. Another example 
is the possible liability upon suit for damages for personal injuries, or 
otherwise. Contingent Liabilities are shown in memorandum form on 


34 


the Balance Sheet as a distinct classification, usually following the Current 
Liabilities, but without definite figures carried out. The maximum amount 
of each class of contingent liability, when it can be ascertained, should 
be stated in the memorandum. 


Surplus. 


If the total amount of asset value, correctly stated, exceeds the com- 
bined amount of capital stock and liabilities, a surplus exists. Surplus 
appears on the credit side of the accounts, either in one account, or in 
two or more accounts, such as Surplus, Undivided Profits or Profit & Loss. 

Dividends declared should appear in a Dividends Payable Account, 
and, being an account payable, the collection of which can be enforced 
by the stockholders, should be classified with the Current Liabilities. 

The real book investment in the corporation is the sum of the capital 
stock and the surplus, and, in contemplation of a dissolution of the cor- 
poration, the two merge, for each stockholder would be entitled to his 
pro rata share of the assets after liquidation of the liabilities, whether 
the amount was more or less than the par of his stock. 

From the viewpoint of the corporation as a going concern, however, 
there is a distinction between capital stock and surplus, in that the latter 
may be paid to the stockholders in dividends, while the capital stock 
may not be returned except upon formal dissolution. A useful purpose 
may, therefore, be achieved by stating the facts so that the distinction 
is apparent. 

The surplus is displayed as a final division on the right side of the 
Balance Sheet, divided into as many items as may be desirable, the total 
being carried out to the amount column. If a departure can safely be 
made from the established custom, the capital stock may be displayed 
in conjunction with the surplus, the total carried out disclosing the entire 
capital investment of the undertaking. It is far more usual, however, 
to carry the Capital Stock into the Capital Liabilities. 

In the case of a deficit, that is, an amount by which the combined 
capital stock and liabilities exceeds the amount of assets, correctly stated, 
there will be no surplus and the deficit appears as a debit balance. It 
is displayed as a final amount on the left side of the Balance Sheet, the 
Deferred Charges, in such a case, immediately preceding it. If it were 
desirable to show the real capital investment, the deficit might be de- 
ducted from the amount of capital stock on the right side, although this 
is unusual. 

In case a Balance Sheet has been prepared and published in one 
form for years, or in case the established custom requires a certain form, 


30 


as is apt to be the case in public service corporations, the accountant 
is frequently under the necessity of yielding, after presenting his own 
views as to display, to such established usage. So long as the essential 
facts are disclosed, the accountant is justified in sacrificing, to some 
extent, his views on matters of technique. 

It is not intended, at this point, to consider fully the principles under- 
lying the valuation of assets, but it must be borne in mind that the amount 
of invested capital, as disclosed by the capital stock account and the 
surplus or deficit account, is dependent upon such valuations; and that 
values fixed on the basis of a going concern differ from those fixed on the 
assumption of a realization. It follows that, as a practical matter, capital 
stock furnishes little beyond units of ownership as a basis for the distri- 
bution of whatever profit there may be available for dividends, and as 
a basis for the distribution, upon dissolution, of whatever is left after 
liquidation of liabilities. 


Working Capital. 

The excess in the amount of the Current Assets over the amount of 
the Current Liabilities is the Working Capital of the enterprise, being 
the net amount of asset value available for carrying on the current opera- 
tions of the undertaking. In the example of the manufacturing corpo- 
ration before given, with a capital stock of $100,000 and an investment 
of $80,000 in permanent plant, the Current Assets consist entirely of 
cash, $20,000, and there being no Current Liabilities, the Working Capital 
of the corporation is $20,o00. Working Capital does not appear as an 
account with a balance, but its amount is determined from classifying the 
Current Assets and the Current Liabilities, and determining the excess 
of the former over the latter. 

_ The proportion of Working Capital to the entire amount of capital 
invested varies with the different lines of business, and even with the 
individual undertakings in the same line of business, according to pros- 
perity and the views of different managements. In the case of collec- 
tion of money in advance for goods sold or services rendered, little or 
no Working Capital is required, because the necessary funds for carry- 
ing on the operations are advanced by the persons to whom the product 
is sold, or for whom the services are rendered. 

Thus, in the case of a railroad, a small percentage of Working Capital 
is required for the reason that a large part of the tolls for the services 
rendered, both in transporting property and persons, is collected in advance 
by the railroad company. In addition to the payment in advance thus 
secured, a railroad company often pays its employees monthly, and some- 


36 


times not until the roth or 15th of the month succeeding the one in which 
the services are rendered; and, through its financial responsibility, it is 
able to secure a longer period of credit for its supplies than would other- 
wise be possible. In these respects it occupies a peculiarly fortunate 
position in regard to the necessity for Working Capital, collecting largely 
in advance and taking advantage of long-time credit. 

As contrasted with this, a concern that sells on long time, for ex- 
ample, an undertaking that manufactures sewing machines that are sold 
directly to the consumer on time extending from one to two years, to 
be paid in instalments, must have a very large proportion of its capital 
free for financing the current operations. An initial Working Capital, 
unless of liberal proportions, would soon be converted into accounts receiv- 
able, the collection of which would extend over long periods of time. The 
loss of interest thus incurred must, of course, be compensated by a larger 
selling price of the product than would otherwise be necessary. 

In examining the Balance Sheet of a business for the purpose of 
extending credit or otherwise, the first consideration, as a rule, is to 
determine whether the Working Capital is sufficient for the needs of the 
particular business. If the condition is unfavorable in this respect, the 
negotiation of a short-time loan, or an advance, does not change the situa- 
tion so far as the Working Capital is concerned, for the reason that while 
the Current Assets increase to the extent of the amount of the loan, there 
must be set up a Current Liability for the same amount. The only effect 
of such a procedure is to provide funds to pay the most pressing of the 
Current liabilities, at the expense of setting up others to come due a 
little later. If sufficient Working Capital does not exist, the situation 
can be relieved permanently only by the direct contribution of additional 
capital by the proprietors, or by the indirect contribution through earn- 
ings that are not withdrawn but left in the enterprise for the purpose of 
providing the necessary additional capital. 

The case often happens that sufficient Working Capital will be in 
the undertaking at the commencement, but through the need for increas- 
ing the plant, the Working Capital is sunk in the permanent plant, thus 
creating an unfavorable condition as to the Working Capital available 
for the enterprise. Thus, in the case first cited, in which $20,000 of Work- 
ing Capital was available in the first instance, if the legitimate additions 
to the plant should cost $25,000, making a total charge to that account 
of $105,000, and no additional capital had been contributed, or allowed 
to remain in the undertaking from profits secured, there would have been 
an excess of Current Liabilities over Current Assets of $5,000, instead 
of a Working Capital of $20,000. If a mortgage, securing a long-time 


oY. 


loan, that could fairly be classed as Capital Liability, had been placed 
upon the permanent plant, it would have relieved the situation to the 
extent of the funds, and for the time of the loan, thus secured. If a re- 
newal of the loan could be made at its expiration, upon the same security, 
the Current Assets would not be needed to meet the liability, and the 
Working Capital would remain intact. The only unfavorable effect as to 
the current operations from such a procedure would be the interest charge 
on the loan, that would have to be made from earnings. 


Capitalization. 


In determining the capitalization of an enterprise, no better general 
rule can be laid down than it should have as capital the amount of funds 
with which the business can be most economically conducted. Thus, 
if a corporation is organized with a capital of $100,000, which is suffi- 
cient for its needs eleven months of the year, but during the twelfth month 
it needs an additional $50,000, it might be more economical for the cor- 
poration to borrow the $50,000 for the month than to carry permanently 
a capital of $150,000, a third of which would be idle or invested at a low 
rate of interest for eleven months of the year. In such a case, granting 
that the loan of $50,000 could be effected beyond reasonable doubt, the 
capital of the corporation should doubtless be $100,000. 

In the case of the incorporation of an enterprise with a capital of 
$100,000, in which $150,000 of capital was permanently needed, the funds 
might be obtained by placing a mortgage for $50,000 upon the permanent 
property of the undertaking. Assuming that such a loan could be renewed 
upon its expiration by repledging the same assets, the funds secured by 
the loan would be available for the purposes of the corporation, without 
recourse to the current assets. It is obvious, however, that such financing 
is not as conservative, aside from the fixed interest charge involved, as 
where the entire amount of capital needed is supplied by the proprietors 
by stock issues. In the latter case, there is a liberal borrowing capacity 
available in the times of financial necessity that are reasonably sure to 
come to every enterprise, no matter how well managed. In industrial 
corporations, the difficulty of renewing capital habilities is apt to be great 
in times of commercial depression. In public service corporations, it is 
more usual to find the permanent plant mortgaged heavily, because in 
the nature of such corporations the enterprise continues indefinitely, and 
under ordinary business conditions, the renewal of such loans can be 
made without difficulty. 

Granting sufficient capital in the first instance to provide the neces- 
sary permanent plant, and a reasonable amount of working capital, it 


38 


may be found necessary, through increased business, to increase the per- 
manent plant, and this is frequently accomplished by the sale of long- 
time securities, such as bonds secured by a mortgage on the property. 
The work of improvement may be well under way, and a part of the securi- 
ties sold to defray the cost thereof, and then difficulty may be encountered 
in disposing of the remainder of the bonds. In such a case, it not infre- 
quently happens that the work of improvement cannot be altogether 
stopped and is carried on out of funds secured by short time loans, the 
intention being to convert such short-time loans into a bond issue as 
soon as the market conditions permit. This condition becomes dangerous 
in the event of a depression, for the short-time loans may have to be paid 
without an opportunity to convert them into the long-time issue. The 
corporation may thus be forced into insolvency and a receivership. 

Insolvency may result from the lack of sufficient cash funds to meet 
maturing obligations, even though the enterprise may technically have a 
surplus of assets over liabilities, or even a surplus of assets over com- 
bined liabilities and capital stock. The mere possession of a credit to the 
Profit & Loss Account or Surplus Account does not necessarily indicate 
that funds are available to meet maturing obligations, for the profits 
may be invested in the permanent plant, or tied up in current operations 
in such a way that they cannot be realized upon for the purpose of meeting 
obligations. In the same way, and for the same reason, a corporation 
may have a profit and still be unable to pay a dividend, through lack of 
cash with which to make the payment. 


Illustrative Balance Sheet. 


For the purpose of illustrating the distinctions that have been made, 
the accounts of the manufacturing corporation, with a paid-in capital of 
$100,000, heretofore mentioned, will be used. The post-closing Trial 
Balance at the close of the second year’s business was as follows: 


39 


THE AMERICAN MACHINE CoO. 
Post-CLosinG TRIAL BALANCE AS AT DECEMBER 31, 1904. 


RR SOO ars) Ce LIER NES ARE CLA UAC RN ON DU Be le le Ay $100 ,000 
Ser MOTt race 2O-NGarvBonds oon) sees eek ie Pe a 25,000 
NEUE TORRE URAL ATS, oot USE UA aR A RR A RL eilas Antale lee far poy $10,000 

OEE Te MS 4 iia ces ee ROA RN OLA UC 30,000 

TEES Te ee OPED |e 6) ede! oid dk 96 aa es MDs aed alae idl Bales 55,000 

Reserve for Depreciation of Buildings... .. MER, SU TEL Rea aC 1,500 
Reserve tor Depreciation of Machinery . ...). 5. s4 4 seis viecaeume seid Pt Ae, 
Reserve for Losses on Accounts Receivable..............20ce00es 425 
Orvanization’ Expense (4 written Off) (o.oo i sinid cb el ddige a vee June I ,000 

RIE TES ECOIVADI@ re hes eb in 4s sick a4 oh beard hla aie a tials eek 42,500 

Bills Receivable......... Keim er sh wid al eet ata) anal lnt elkl laa eal MeL COP AW RAEN el ad Tie RN I2,000 
ate halhy) 5's eng Se alg mM doh a Wick Cie hada e ete digie adalat 5,500 
Minemuaryenstotes and Labor. ii ii. Se BO 7,500 

Memetmer  Pimiened otock: (Cosk) 35's «iia 's cls yak deal le tleie dare oiled pall 9,000 

RR Ey LOSE ET TE Ne Viparere emit ole lee Meiers eae. a tenua 19,500 
CT OE NESTE ATTN at ATOR LO le TE I QP OD EY A 15,000 
ci le GE SEALS) (ed IE WR Pik ds Toh a ae TRL AULD A UE a I 4,000 
SG CO Oe BRD Ce nS a Be OSS CME MOLD Aid oe AVaes 


$172,500 $172,500 





The simplest rule in Balance Sheet construction, in corporations, is 
to display the assets in the order of their probable realization, beginning 
with the slowest, and the liabilities in the order of their probable liqui- 
dation, beginning with those maturing last. Following this rule, the facts 
would be displayed as under: 


THE AMERICAN MACHINE CoO. 
BALANCE SHEET AS AT DECEMBER 31, 1904. 


_ (Deficient 
in Technique) 


Assets. Liabtlities. 
Organization Expense........... $1,000 CAD ILAL SeOC HI! oie «ole wink aay tala ten $100,000 
oe, ARTETA een 10 ,000 First Mortgage 20-Year Bonds... 25,000 
RMSE EM tees. a\cil sls ai dave 30,000 Accounts) Payable Aiea 19,500 
EL es a) Sky 4 as ni/etaye, os 55,000 Bills HAVA Ble an, tales ta atl iat) games 15,000 
Inventory of Stores and Labor... 7,500 Dividend Payable, Jan. 2, 1905... 4,000 
Inventory of Finished Stock..... 9,000 Reserve for Depreciation of Build- 
Accounts Receivable............. 42,500 pha tLe MI (Re ANG LAP PCN ME teas fe I,500 
Patent @CEIVADIO 2 2 oasis» etevn 514 12,000 Reserve for Depreciation of Machi- 
MEP IMME RTE tet) 250 i's: shal yk lay ol iare ecb 5,500 TOL e id cv tviaiuea. a Grelaaenee 2,750 
Reserve for Losses on Accounts 
Recétvableose se ee a 425 
Undivided! Profits i) un acme 4,325 
$172,500 $172,500 


The above Balance Sheet falls short of technical perfection in that 
the net amount at which the Buildings, Machinery and Accounts Receiv- 
able are taken into the Balance Sheet can be determined only by an 
arithmetical deduction of the respective reserves, a process that should 
be carried out in the construction of the Balance Sheet. 

It is technically defective in that the investment in plant and 
machinery is not shown in total, so that its relation to the Capital Stock 
and the current assets may be grasped. 


40 


It is technically defective in that the current assets and current 
liabilities are not shown in their respective total amounts, so that their 
relation to each other, and its effect upon the business, cannot be ascer- 
tained without additions. | | | 

It is technically defective in that under the caption Liabilities appear 
items that cannot properly be so classified. Gikty ih 

It is technically defective in that the amount of capital that may 
reasonably be expected to remain in the enterprise cannot be determined 
without an arithmetical calculation. + 

In short, it amounts to little more than a post-closing trial balance, 
and does not fulfill the accounting requirement that, in the Balance Sheet, 
the facts of the post-closing trial balance must be rearranged, classified, 
condensed, and set forth in a way that will convey the greatest amount 
of information. 

The technical defects may be overcome by recasting the Balance 
Sheet in the form generally adopted by accountants, as follows: 


4I 


Szg‘Lorg 


Celt r Sree rome A ee ae eet ee eee es et OOS J PoplAlpuy) OOO'r 
*sn)G4nG 
SLofol 
00S ‘gf eco ate Sle ‘cb @ Vers, 6 be ele 5 6 © “SorpIqery quoting [210 
ooo'r Us 5 OV bes 0 8 a0 ote es Soot ‘zs ‘uel ‘giqeAeg puoprlaiq 
ooo! Cr e e660 6206-0 v6. 6 0 O. S00 6+ 6 Bie Spel eles oe ew ee eters ne aqeAeg SIT 
ooS ‘61¢ wee) ol 8 a. 6 fete» Py ewe ar ele e ie bw pe ‘aiqeAeg syUNnoo0y 
‘SOUMIGDYT WMa4ang 
o$L‘ 064 
o$z2‘2S 
000‘ Szr¢ Be ee ee ee ee SATIN EET JUpId es) [eqOL 00S ‘gz 
000'Sz 0 Es Ra Ae PRE ee eae eee spuog 19x -0z 983710] SILT 
ooo! oorg CP CD Ce > SS ew SO SG Peele va. arwus) 6 ov ow, oY. 6 ene Crs © 3904S jeqideg ooo! org 


‘sauyrqnyy wouddD 


‘voor ‘1 aaaWaOAG LV SV LAGHS AONVIVYG 


Szg ‘Lord 


Pm a ak OR ee OA 2 . ‘(yo 1194)TIM §) ssuedx 7 UOlyezIUeSIO 
“SaBADYD) pasdf{aq 


sjassy JUOIIND [e10], 
00S ‘ ¢ oe eee eee eee eee eee see ee o eee e eee sees eeeoeees yseg 
ooo en ee age” ora ees Eee woe Seem ose ee ee BIGVAIIID yy STIG 
SLotzv 

Szv "4555 + S9sso’T IO] DAIOSOY SSo’T 

ooS ‘ zoe ee IIGVATIIO YY syUNO.Yy 
oo$ ‘g1g¢ —————— 

000! 6 a ee 3904S peystury 

00S ‘ Le Se a Sx Cee iat bet at Pet Ioqe’] pue So101S 

: SOLIOJWIAUT 
"SJOSSY JUALIN) 

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aS See ok ied eR RE OL BL uorze1oeidaq 10} 9AIOSOyY SSo’T 
coo! SS¢ A et at Te a eG ay is CK Fe ee at ALOUTyOR 
elt hee bane Og Ee A Ma Ss uorzyelerdeq IO} DAIOSOYy Sso’T 
000 ‘ of o- 0 0 @ (© 0.0 6 6 6 6 6 8 6 8 6 8 0 6 Ue © 6 6 Care © 6 6 678 6 eH em ssuIp[Ing 
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‘(OO UNIHOVIW NVOISHNV AHL 


42 


It can be seen at a glance from the above statement that the funds 
supplied from stock issue and mortgage bonds amount to $125,000, out 
of ‘which $90,750 is sunk in the plant, leaving $34,250 as working capital 
from this source. Adding the surplus, amounting to $3,325 after deducting 
the deferred charge, gives an aggregate working capital of $37,575. A 
more direct way to obtain the same information is to deduct from the 
total amount of current assets, $76,075, the amount of current liabilities, 
$38,500, leaving the same amount as achieved before, $37,575. 

It is obvious that the current assets, out of which current liabilities 
must be met, are about as 2 to 1, although about one-half of the excess 
is in inventories, the slowest of the current assets, and that $4,000 of the 
$5,500 cash is needed immediately for dividend purposes. 

It may be claimed that the inclusion of Capital Stock under the cap- 
tion Capital Liabilities is technically incorrect, but the customary technique 
is adopted for reasons heretofore given. 

There can be no better rule of technique than that accounting state- 
ments should be constructed in such a way that the maximum amount 
of information may be gained by the layman with the least expenditure 
of effort. 





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2 ADVANCED mT EEORY AND PRACTICE 


~ OF ACCOUNTS. 
ORGANIZATION AND FINANCE. 


By HOMER ST. CLAIR PACE, ©. P. A. 
CORPORATIONS—LECTURE IV. 


REVENUE OR INCOME. 


Perea (NOMINAL. TISTINCTIONS 2. cae a hag PROT Ree tee a 44 
EXPENDITURE. BaP EC Maley Sea, oan Cle Ree ule gene gee 46 
PRINCIPLES OF VALUATION. Re on indae eg rites cul ae cael tcd Wika idenoue Diane 46 
FEULEMENTS OF INCOME. 12.20 eile Me Lat cae, ie ie ena CAS 
- ILLUSTRATIVE Tyee hocdoNTe. ee Oa eee, 49 

| eo 


COPYRIGHT, 19012, BY 
HomeER St. Cuatr Pace. 


ee 


vee 
VERGE 
eat 





ADVANCED THEORY AND PRACTICE 


OF ACCOUNTS. 
ORGANIZATION AND FINANCE. 


BY OOMER Sta CLAIR PACE. C..P. A. 


CORPORATIONS—LECTURE IV. 


———$———- 


REVENUE OR INCOME. 


In General. 


The term revenue has two commonly accepted uses. It is used, 
first, to designate the income of a government, or a division of a govern- 
ment, arising from the imposition and collection of taxes, duties, etc. 
Hence, the use of the term revenues to describe the total of such income. 
The term may also, but not necessarily, in the case of a government, 
include the proceeds of the sale of stocks, lands or other property. 

The term revenue is used, secondly, to designate the income of organ- 
izations other than governmental bodies. It is a generic term, embracing 
all profits, returns, rents, interest, issues, earnings and income, received, 
or the right to which has accrued or been gained, irrespective of the desig- 
nation that may be applied to such element in the specific undertaking. 

Thus, in a mercantile concern, the excess of what is obtained over 
the cost of obtaining it is known as profit. In case the excess of the selling 
price over the cost price of the goods sold is called gross profit, the balance 
that is left, after deducting all other costs incurred, is known as net profit. 
It will be obvious that profit and net profit are the same, the latter term 
being used in contradistinction to gross profit. 

In the business of the transportation of property and persons, the 
aggregate received for the services rendered is known as gross earnings. 
After deducting therefrom the direct costs of operation, but excluding 
rentals, interest, and, in scme cases, taxes, the balance is known as net 
earnings. After deducting the rentals, interest and other charges not 
before taken into account, a balance, known as net income, available 
for distribution as profit, is obtained. 


Copyright, 1912, by Homer St. Clair Pace. 


44 


In the case of organizations maintained for purposes other than profit, 
as, for example, a club, the dues and collections applicable to the pay- 
ment of -running expenses and the maintenance of property, are known 
as revenue or income. Inasmuch as the term revenue may originally 
have implied a return or rent, instead or an assessment, its application 
to non-profit organizations, that collect from their members the amounts 
necessary for their purposes, may be questioned. However, the idea 
of a return does not enter into its common use to denote governmental 
income, and its use to designate the income of non-profit undertakings 
should hardly be barred on this account. 

In the accounts of an estate, the returns from the use of the property 
are known as income. 

The illustrations could be multiplied, but enough have been given 
to indicate that various terms and distinctions develop and are used in 
different classes of undertakings. The term revenue is broad enough 
to embrace all. 

It should be noted, however, that the term income has a common 
use as a generic term, covering everything that is embraced in the term 
revenue. It is probably a fact that income is more frequently used by 
legal writers and courts, while revenue is more commonly employed by 
accountants and corporation officials. So far as published definitions 
are concerned, it would appear that the term revenue is used chiefly to 
describe the income of a government, while the term income is most fre- 
quently applied to the revenue of private concerns. Enough has been 
said to indicate the interchangeability of the two terms. 

In this Lecture it is intended to consider, in detail, the subject of 
revenue or income as it applies to organizations other than governmen- 
tal bodies. 


Real and Nominal Distinctions. 


In conducting an enterprise under ordinary conditions, a portion 
ef the capital will be invested in capital assets, held for the permanent 
needs of the concern. The remainder, whether held in cash, or partly 
or wholly converted into assets that are to be turned over, will constitute 
the current assets. There may be liabilities, classified, according to their 
time of maturity, into capital liabilities and current liabilities. There 
will be a capital account or accounts, disclosing the amount of investment 
or ownership. In the assets and liabilities will be included the personal 
accounts, with which the capital account, showing accountability to the 
owners, is classified. All of the elements enumerated may be classified 
as real. 


45 


As distinguished from the foregoing, the accounts that are raised 
to record revenue, embracing all returns, profits and income, and the 
expenditures or charges that are properly offset to such gross revenue, 
may be said to contain nominal elements, or those that exist in name only, 
raised for the purpose of measuring, for a definite period, increases and 
decreases of assets and liabilities. Their nominal nature may. be seen 
from the fact that, having served their statistical purpose, the elements 
may be canceled against each other and permanently closed. 

Exception may be taken to the inclusion of the capital, or owner- 
ship, account as a real element, on the ground that it only measures a 
net asset value, and is not itself that value. However, it measures a 
real fact as to proprietorship, while a true nominal element may be offset 
and closed from the books. The balance that remains after the nominal 
accounts have been offset becomes, in the case of a profit, a real element 
of accountability to the owners. An ordinary liability is a sufficiently 
real element, although it but measures an amount that, theoretically, 
must be satisfied from the assets contra. 

The distinction between the real and nominal elements is important 
in determining net revenue or income, because the cost of an expense, 
charged to an asset account and allowed to remain therein, overstates 
the net revenue to its extent, and charging the cost of an asset, the value 
for which remains, to revenue, results in an understatement, to its amount, 
of the net revenue. ; 

An illustration of a distinction between capital and revenue expen- 
diture is furnished in the case of a railroad company that is renewing 
75-pound steel rail with 1oo-pound rail. The original steel, and the 
track, should be maintained by charges to revenue. Therefore, only the 
excess weight of 25 pounds is a proper charge to capital. The charge to 
revenue for the 75-pound renewal, would be reduced by a credit for the 
residual value in the steel removed. The curious condition of such resid- 
ual value being in excess of the cost, so that the renewal is made at a 
profit, has been known to occur through fluctuations in the values of 
steel. 

An instance of an incorrect distinction may arise, for example, in 
the case of the salary of an engineer, whose time is divided equally between 
maintenance work and new construction, but which is charged to capital. 
It would properly be divided one-half to each. Such an erroneous dis- 
tribution would overstate net revenue to its amount, and load capital 
assets with an operating expense. 


46 


Expenditure. 

An expenditure is an amount paid, or to be paid, and may result 
in the acquisition of an asset, in which case it is a capital expenditure, 
a capital outlay, or, as it is sometimes called, merely outlay; or an expen= 
diture may result in a cost or expense, chargeable against revenue, in which 
case it is called a revenue expenditure. 

The use of the word expenditure in the term Statement of Revenue 
and Expenditure, or Statement of Income and Expenditure, obviously 
refers to amounts paid, or to be paid, that are a charge against gross 
revenue or income. Expenditure, like the term expense, may apply to an 
actual payment or disbursement of cash, or to a liability incurred, to be paid 
later. Unlike expense, however, it may apply to capital as well as to 
revenue. 

While a capital expenditure, strictly, is one for which asset value 
to the extent of its amount remains, in practice the terms outlay, capital 
outlay, or capital expenditure, are used only to denote an expenditure 
made for the betterment of the permanent assets with a view to increasing 
the earning capacity. The strict definition would include, therefore, the 
purchase of merchandise, or similar current assets, to be used in the 
revenue end of the business. The latter, in accepted practice, despite the 
strict definition, would be classed as a revenue expenditure in the same 
way as insurance paid in advance. The unused values would be con- 
sidered more in the nature of deferred charges to a revenue or income 
account of a later period. 


Principles of Valuation. 


In view of the well-settled principle in accounting that the profit 
shall be stated as the net amount earned, and inasmuch as its determination 
depends, after the deduction fram revenue or income of the direct expenses, 
upon the proper valuation of assets and upon proper estimates of the 
shrink in realization upon those that are held for realization, a full con- 
sideration of these subjects is desirable. 

The income itself is credited, if, during the period, it is earned, 
accrued or gained, irrespective of its actual receipt in money or its 
equivalent. 

? The direct expenses, such as wages, salaries, rents and insurance, 

the benefit of which applies to the period for which the gross income 
is taken into account, whether actually paid in cash during the period 
or not, are deducted from, or charged against, such gross income. 

So far as the assets of an enterprise are concerned, they will consist, 
as has been pointed out, partly of capital assets, or those that are more or 


47 


less permanent in their character, by the use of which the business is carried 
on, but which are not acquired or held for the purpose of realization. 
Thus, land may be acquired and a building erected thereon for the use 
of an enterprise. If the asset is one that depreciates, that is, becomes of 
less value through use or the effluxion of time, as would be the case with 
the building mentioned, such depreciation, being an inevitable accom- 
paniment of the returns or profits made through the use of the building, 
would be a deduction therefrom. The principle is that the capital assets 
should be kept intact out of revenue. 

This means not merely that the asset, be it machinery, buildings, 
or other asset subject to depreciation, shall be kept in condition for use \ 
by repairs, but that there shall be an amount withheld from the returns 
that will be sufficient ultimately to replace the asset when it has become 
obsolete through changed conditions, inventions, or otherwise. 

Subject to being kept intact out of revenue, the capital assets should 
be valued at their cost. Their realizable value, in view of the fact that 
they are not purchased or held for realization, should not be considered. 
Thus, in the case of the land mentioned, the fact that similar tracts are 
selling for more or less should not affect the profit-making capacity and 
showing of the concern using the land. The land was, presumably, worth, 
as a part of the necessary equipment, its cost, and not being subject to 
depreciation, its value may ordinarily stand at its cost. 

In special cases, appraisements and revaluation are necessary in 
order to bring the state of the accounts more nearly into accordance with 
conditions, but in such cases the fluctuations should not be allowed to 
obscure the trading or operating results. 

There is a distinction between the valuation of assets upon the basis 
of a going concern, that is, one that is to continue in business, and one 
that is to be realized and liquidated. An asset may be worth its full cost 
to a concern for its particular business, and still have a realizable value of 
only part of such cost. So long as the intention and ability to continue 
business exist, the cost, subject to proper allowances for repairs and 
depreciation, is the proper basis of valuation. 

In the case of the realization of a capital asset, the profit or loss is 
treated as any other profit or loss, except that care should be taken to 
avoid confusing it with trading or operating results. Pending realization, 
appreciation may better, in the majority of cases, be disregarded. 

Current assets, unlike capital assets, are held for realization only. 
Their worth consists not in their peculiar adaptation to the undertaking, 
but in what they will produce upon realization. Thus, accounts receiv- 
able are carried as assets at their estimated collection value, the estimated 


48 


loss being provided for by a reserve account, to which the losses, as made, 
are charged. Inventories of material are stated at cost, or market price, 
whichever is lower. Throughout, conservative action is required in order 
to avoid_an overstatement of profit, a much more unfortunate occurrence, 
from an accounting viewpoint, than an understatement. 

Losses or expenses that must be charged against revenue on account 
of adjustment of asset values, may be designated as indirect charges. 
They are as properly chargeable as the direct expenses, but present the 
distinction that their amount is dependent, to a large extent, upon judg- 
ment. They, therefore, present to the accountant the opportunity for 
the exercise of ability of a higher order than is called for in the determina- 
tion and deduction of the items of direct expense. 


Elements of Income. 


The Statement of Revenue & Expenditure that would be constructed 
upon the principles given would present elements as under, although 
the technical arrangement, in practice, would be different: 


BLANK & BLANK 


STATEMENT OF REVENUE (OR INCOME) & EXPENDITURES FOR 
YEAR ENDING DECEMBER 31, 1904. 


REVENUE (OR INCOME). 
Gross Revenue (or Income) including all increment 
through trading or operating, whether actually 
received in cash (OT NOU 0... 47s. peeetee eee $ fo) 


EXPENDITURES. 
Direct Expenditures, whether actually paidin cashornot. $ ° 
Indirect Expenditures, including adjustments upon realiz- 
able assets and provision for maintenance of capital 


ASSETS 6 6a SI ey eae etn $ o § 6) 
Balance, Net Revenue, Income or Profit ...... | $ fe) 
Extraordinary Income or Expenditure........ $ ° 


EJ 
©, 
ct 
rab) 
— 
ie 27 
O 


49 


Illustrative Income Accounts. 


For the purpose of placing before the student, for study, the income 
accounts of large corporations, three selections have been made, all of 
which have been prepared and published in the report, or running 
form. It is not intended to approve or disapprove the form in any of the 
cases, but the object is to reproduce, from practice, statements in which 
the attempt has been made to meet the various essentials of an income 
account. 


GUANAJUATO CONSOLIDATED MINING AND MILLING COMPANY 
STATEMENT OF PROCEEDS AND EXPENSES 
January 1 to December 31, 1907 


Bullion, Concentrates and Shipping Ore.................. $673,341.52 
Bocmom ining, .Milline. and Cyaniding....... 0. ene. 385,919.61 


$287,421.91 
Treatment Charges on Concentrates and 


ene C Cane ee eel, Ue eae eee $59,116.69 
Bullion Expense, including State and Federal 
NM eee ad vie,8 x 4 yinltia ex gd oie 20, 628.96 79,745-05 
RE MOET ern ie NL ho utah ga aig CAR oc Ve WAR RE $207,676.26 
PreerseL tcl WUNeT OOUICES . sce oa oe hee fi 1,686.97 
VETOED Sec R ae Ae aie eco es Pe Be ee $200, 363.23 
Taxes on Minor Properties, Legal Expense, Transfer, Regis- 
trar, Salaries, Maintenance of West Virginia Office, etc.... 19,433.42 
MMO TELCO CALIIOO 7 oe ts. a ol tale acta © eee ens $189,929.81 


Bree ONG, Interest, paid Out. 2.6. os dees eee} 20,156.69 


GE OES LAM pie Bs a ee EN $169,773.12 


50 
CORN PRODUCTS REFINING COMPANY 
INCOME ACCOUNT 


Year Ending February 28, 1910 


Profits from Operation. 9 finc.:.5 6) ae $3,437, 317-81 
Interest on Loans, Deposits and Overdue Accounts....... 74,842.55 
Interest and Dividends on Securities Owned............. 52,022 .5e 
Rentals from Real Estate—Not Used in Operation....... 10,297.23 
Total. Income. » «S.J ee ee $3,574,480.92 
Deduct: 
Interest on Bonded Debt................ $374,302.90 
Interest on Borrowed Capital............ 22,095.13 
TAX@S . os ts eke ee 102,878.70 
Instirarice: sx 5.2. eo yee aa 103,145.30 
Miscellaneous Expenses................. 22,575.48 
Reserve for Profit-sharing............... 175,000.00 
Depreciation. on Properties:.3 7s. eee 382,547.14 
Discounts'on Bontis Sold) 200 ce or 250,000.00 
Reserve for General, State and Corporate 
Taxes . . Gut.S0h Fee ce es ee 70,000.00 
Total. Deductions ~ 3.0: diskette ot ae ee I,502,544.65 


Net Income for Year cai - ilo Sins ce eee $2,071,936.27 


51 


UNITED STATES STEEL CORPORATION AND SUBSIDIARY COMPANIES 


CONDENSED GENERAL PROFIT AND Loss ACCOUNT 


For Year Ending December 31, 1909 


ieroes Receipts—Gross Sales and Earnings. 4... 6.6 3625'4 doe yo50 se vas 


Operating Charges, viz.: 

Manufacturing and Producing Cost and Operating 
Expenses, including ordinary maintenance and 
repairs and provisional charges for depreciation. . 

Administrative, Selling and General Expenses, and 
Employees’ Bonus Funds (not including general 
expenses of transportation companies).......... 

Taxes (including allowance for corporation excise 


Less, Amount included in above charges for pro- 
visional reserves for depreciation now deducted 


for purpose of showing the same in separate item 
MPIME Or aS SCC DOIOW bi ee cee cee alee as women 


RCT em ee ey ay come Fer te a yo, a tek he ee Se UG Sh) eg han, tee 


Sundry Net Manufacturing and Operating Gains and 
Losses, including Idle Plant Expenses, Royalties 
received, Adjustments in inventory valuations, etc.. 

Meneais received... ...2..... Py Clie sl dss be Carat naarate 


$507,136,156. 


15,460,613. 


8,704,193. 
3,621,652. 


$5 34,922,576. 


I7710,453" 


$2,424,787. 
960,594. 


39 
12 


63 


Total Net Manufacturing, Producing and Operating Income before 


deducting provisional charges for depreciation....... 


OTHER INCOME 
Net Profits of Properties owned, but whose operations 
(gross revenue, cost of product, expenses, etc.) are 
foerernided im this statement. ..... 2... cee nine 
Income from Sundry Investments and Interest on 


I CRE Sk ag pile Ue cio aie a ve ee bg oe wes 


ec mes ester iat ae et oe ed ba ag aE be OREO Be eee 


$672,646. 


2,759,970. 


55 


08 


$646,382,251.29 


511,204,262 .50 


$135,177,988.79 


3,385,382 .24 


$1 38,563,371 .03 


3,432,616.63 


$1 41,995,987 .66 


* Includes charges for ordinary maintenance and repairs, approximately $35,000,000. 


Total;-brought forwards ay. bay «saa nk eine eee an eee nee 
INTEREST CHARGES 
Interest on Bonds and Mortgages of the Subsidiary 


Companies i tissis cui suis Stele stars Majo) sta acetate pier $7,728,822 .79 
Interest on Purchase Money Obligations and Special 
Deposits or Loans of the Subsidiary Companies.... 158,355.39 


Balance, being the aggregate earnings of the several companies for 

the year before deducting provisional charges for depreciation. . 

Less Net Balance of Profits earned by subsidiary companies on sales 
made and service rendered account of materials on hand at close of year 
in purchasing companies’ inventories, and which profits have not yet been 
realizedjin cash from the standpoint of a combined statement ofthe 
business of the U. S. Steel Corporation and subsidiary companies....... 


Earnings for the Year 1909, per Income Account............... 
Less Allowances for various Depreciation Funds.............. 


Net ‘Earnings in the Year 1900... 4c. <n ee eee a ee 


$141,995,987- 


7,887,178. 


$1 34,108,809. 


2,617,395. 


$131,491,413. 
23,710,814. 


$107,773,099. 


66 


48 














ADVANCED iecey AND PRACTICE 
OF ACCOUNTS. 
ORGANIZATION AND FINANCE. 
By HOMER ST. CRATR: PACE, GC. Poca: (N.<Y.) 


CORPORATIONS—LECTURE YV. 


DIVIDENDS. 


REALIZED, AS DISTINGUISHED FROM UNREALIZED, 


PORE Sry hea etic oh CO Mg ane ohiuie estab s 55 
WVORKING (ARITAD gh ea wae per 58 
PIBCLARATION OF IJTVIDENDB arn ec eee ok ee 59 
DLVIDENDS VAYABLE ACCOUNT E eo ocm ii boson Booey 60 


STATEMENTS DISCLOSING APPROPRIATIONS OF INCOME. 61 


COPYRIGHT, 1914, BY 
HOMER ST. CLAIR PACE. 


PACE .& PACE 


. PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


30 CHURCH STREET, NEW YORK CITY 


ah 7 


, % 
* ‘ 
5 ky ey 
= fan SAG 





ADVANCED THEORY AND PRACTICE 


oF ACCOUNTS. 
ORGANIZATION AND FINANCE. 


HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
CORPORATIONS—LECTURE V. 
DIVIDENDS. 


In General. 


Private corporations may be considered in two general classifications, 
VIZ. ; 

1. Non-Stock Corporations, or those organized for purposes other 
than profit, such as a library or a religious corporation: 

2. Stock Corporations, or those organized for the purpose of profit, 
such as a mercantile, manufacturing, banking or railway corporation. 

The non-stock corporations are included in the classification, for 
the sake of completeness. While it is not the present purpose to dis- 
cuss this class fully, it may be said briefly that their revenues consist of 
dues, assessments, donations, or other income, the amount being large 
enough, presumably, to meet all running expenses, and at least to main- 
tain intact the property of the corporation. The excess, if any, accu- 
mulates for the benefit of the organization. The deficit, if any, impairs 
to its extent the property. The statement to disclose the facts should 
disclose the gross income, showing by suitable classification the sources, 
and as a deduction therefrom, in sufficient detail, the charges and allow- 
ances that belong properly to the period for which the income is stated 
If a balance remains, it is a revenue excess. If the gross revenue is not 
as large as the charges, the difference is a revenue deficit. 

The distribution of profit to the stockholders, sometimes called 
proprietors, of the stock corporations is effected by the declaration and the 
payment of a dividend, being a pro-rata distribution to the stockholders, 
usually a payment in cash, of a percentage on the par value of stock standing 


in their respective names at a certain date. 
Copyright, 1914, by Homer St. Clair Pace. 


54 


The principles underlying the declaration and the payment of divi- 
dends are applicable, in general, to all corporations, although there may be 
special statutory provisions applicable to a particular class, as, for example, 
banks and trust companies. It is the purpose of this Lecture to state 
the general rules and principles, with the New York statutes and decisions 
particularly in mind. 


Liability of Directors for Unauthorized Dividends. 


It is a well-settled principle of corporation law that dividends cannot 
legally be paid from capital, but must be paid from surplus profits. This 
proceeds upon the theory that the capital of a corporation constitutes 
a fund for the protection of its creditors, to which the creditors may look 
as they would to the personal wealth of an individual debtor. Hence, 
this fund can not be diminished by withdrawals by the stockholders in 
the guise of dividends. Except upon dissolution, or reduction in accord- 
ance with law, the capital cannot legally be distributed. Without an 
elaboration of this principle, which is a matter of law rather than theory 
of accounts, it will suffice to quote the New York statute on the subject, 
which not alone states the principle but imposes a penalty upon directors 
for violating its provisions. It is as follows: 


‘“‘ Liability of directors for making unauthorized divi- 
dends—The directors of a stock corporation shall not make 
dividends, except from the surplus profits arising from the business 
of such corporation, nor divide, withdraw or in any way pay to the 
stockholders or any of them, any part of the capital of such cor- 
poration, or reduce its capital stock, except as authorized by law. 
In case of any violations of the provisions of this section, the 
directors under whose administration the same may have hap- 
pened, except those who may have caused their dissent therefrom 
to be entered at large upon the minutes of such directors at the time, 
or were not present when the same happened, shall jointly and 
severally be liable to such corporation and to the creditors thereof 
to the full amount of any loss sustained by such corporation or its 
creditors respectively by reason of such withdrawal, division or 
reduction. But this section shall not prevent a division and distri- 
bution of the assets of any such corporation remaining after the 
payment of all its debts and liabilities upon the dissolution of such 
corporation or the expiration of its charter; nor shall it prevent 
a corporation from accepting shares of its capital stock in complete 
or partial settlement of a debt owing to the corporation, which by 
the board of directors shall be deemed to be bad or doubtful.”’ 


The ability of a corporation, therefore, to declare and to pay to its 
stockholders profits in the form of dividends depends upon its possession 


55 


of surplus profits. These have been defined to be the excess of assets, 
correctly valued and stated, over the combined amount of capital stock 
and liabilities. Net earnings have been defined to be, generally speaking, 
the “‘ excess of the gross earnings over the expenditures defrayed in pro- 
ducing them, aside from, and exclusive of, the expenditure of Hoes laid 
out in constructing and equipping the works themselves.”’ 

It must be admitted that the decisions available leave much to be 
desired in the matter of definitions and distinctions. Thus, from the 
viewpoint of the accountant, the values of assets would not be correctly 
stated. unless a reasonable allowance, based upon the facts peculiar to 
the specific case, were made for depreciation. It has been held, never- 
theless, that such a provision for the upkeep of capital assets is not nec- 
essarily a deduction from surplus before the distribution of surplus in 
the form of dividends. With the recognition of the necessity for such 
an allowance, as evidenced by the federal act requiring depreciation to 
be provided for in the accounts of railroads, a different tendency in the 
decisions upon this interesting question may be expected. In the mean- 
time, as a general proposition, and notwithstanding the accounting desira- 
bility of the deduction of an allowance for depreciation before the deter- 
mination of surplus available for dividends, the weight of the decisions 
is that it is not necessary. 


Realized, as Distinguished from Unrealized, Profits. 


Cash is ordinarily necessary to the payment of a dividend, and its 
legitimate source lies in the realization of the profits from which the divi- 
dend is declared. But the condition is often found of a surplus far in 
excess of cash, and, in order to illustrate fully how this may arise, the 
principle involved, and its relation to the apportionment of profit, will 
be traced from partnership law and accounts to the distribution of cor- 
porate dividends. 

It may be assumed that A and B form a partnership for the purpose 
of merchandise trading, with a capital of $10,000, contributed in cash 
one-half by each, the profits and losses of which are to be shared two- 
thirds by A and one-third by B. A revenue transaction will be studied 
under several possible conditions. 

In the case of the purchase of goods that cost in cash $9,000, and their 
sale for $18,000, in cash, the gross increase in the asset, cash, would be 
$9,000. If all the costs incurred in carrying on this enterprise were $1,000, 
and were paid in cash, the net realized profit would be the amount by 
which the gross profit, $9,000, exceeds the amount of costs, $1,000, or $8,000. 


56 


If the $18,000 were in the form of accounts receivable, and if, ac- 
cording to the best judgment, every dollar of such accounts would be 
collected, the net profit would, in accounting practice, still be stated as 
$8,000, regardless of realization. Likewise, the entire expense of $1,000 
would be charged against the returns, even though, as a matter of fact, a 
part of it had not been paid. Were the accounting practice otherwise, the 
earning for the period would be obscured by quickness or slowness in 
realization or liquidation. Assuming the realized basis in the case 
given, if no part of the accounts receivable were collected and part or 
all of the expense were paid, a loss would be shown, despite the fact 
that nothing remains to be done except to make settlements. 

It is an essential to successful management, in order to fix respon- 
sibility for unsatisfactory results and to watch over and intelligently to 
direct the activities, that the outcome as to earnings or profits be known 
for successive periods. The net result of realization and liquidation is 
subject to so many contingencies. that comparisons of results dependent 
thereupon are, in the majority of enterprises, valueless. 

It is a rule of partnership law, however, that profits are considered 
as of the period in which they are actually received, or realized in cash, 
and not as of the period in which they are earned. 

The reasonableness of this provision, as a legal rule, becomes plain, 
when it is remembered that, in the absence of realization, the determina- 
tion of profit becomes a matter of estimate or judgment. No one in 
advance can definitely say what a specific asset will realize, and, there- 
fore, in the absence of agreement, the determination cannot be reached 
until realization. 

In practice, the result is determined upon whatever estimates may 
be necessary to reach a conclusion as to profit and loss. Thus, accounts 
receivable may be estimated to produce, upon collection, a certain per- 
centage of their face value. The comparisons necessary to intelligent 
management are made, and the capital interests of the partners are adjusted 
by carrying the results, after taking into account the drawings, to their 
respective capital accounts. The interests of the partners, by agreement, 
express or implied, are thus determined. 

In the case of A and B, assuming that no part of the accounts receiv- 
able are realized, the apportionment of two-thirds of the net profit to 
A, and one-third to B, is dependent upon their agreement. After such 
an agreement, the profit or loss that results from their realization above 
or below the estimated value, is divided in the same proportion as any 
other profit or loss. 


Si 


In the same way, a corporation may have a net profit, a net income 
or surplus, without an equivalent amount of cash. 

In the case of a profit, determined by the established accounting 
procedure, without the possession of cash to an equal amount, the short- 
age of cash would be likely to arise from one of two causes, or both, viz.: 

1. Profits consisting of assets ‘in unrealized form, which would be 
an ordinary condition; 

2. Capital expenditure from realized profits, which is especially 
likely to happen in certain classes of corporations. 

In the case of the payment of a cash dividend under the first con- 
dition, the realization would have to be based, to some extent, upon 
estimates, and the cash would have to be brought into the corporation 
by loan or otherwise. It is questionable whether, in conservative busi- 
ness practice, the payment of such a dividend is justified. In any event, 
the estimate should be conservative; that is, ample provision should be 
made for shrinkage in realization, and preferably the dividend should not 
be for the full amount of profit. If it should happen that the profit did 
not actually materialize, the result would be the payment of a dividend 
out of capital to the extent of such deficit; and presumably the directors 
who declared it would be subject to the penalties of the statute quoted, 
if the rights of creditors were impaired thereby. 

It should be plain that there is a very practical limitation in the 
matter of the payment of cash dividends, and one which operates regard- 
less of the book profit—namely, the possession of cash to an amount equal 
to such cash dividends. 

Considering the second classification, a common instance of the 
expenditure of revenue receipts upon capital improvements is found in 
railroad accounts, and arises through the failure to obtain funds from 
capital liabilities in an amount sufficient to carry through improvement 
work. In such a case resort may be had to earnings, in order to avoid loss 
through suspension of the work, which may be reimbursed later from cap- 
ital. During such a transfer from revenue to capital, net income is tied 
up in a loan to capital, and would be unavailable for dividend purposes. 

The condition may be found of cash on hand, equal to a proposed 
dividend, but received from capital. In the case of its use, the Directors, 
under the statute, would undoubtedly be responsible in the event of the 
failure of the book profit, out of which the dividend was declared, to realize 
the amount of such dividend. 

It is interesting to note at least two instances in the New York 
statutes which specifically prohibit the declaration of dividends. Under 
the Banking Law, interest unpaid, although due or accrued on debts 


58 


owing to the corporation or banker shall not be included in the calculation 
of its profits previous to a dividend, unless the interest is accrued upon 
loans secured by collaterals as provided in the law. 

Among other restrictions upon the distribution of profits in a fire 
insurance corporation, the Insurance Law provides that in estimating 
surplus profits for the purpose of making a dividend upon capital stock, 
there shall be reserved from such profits a sum equal to the amount of 
all unearned premiums on unexpired risks and policies. This, it will 
be seen, is a prohibition of the distribution of profit that has been 
realized, but not earned. 


Working Capital. 


The inability to distribute profit often arises from the lack of proper 
provision for working capital or the use of working capital to increase 
the permanent plant. The natural result of this is that profits are held 
in the corporation to provide the funds in which to carry on the current 
operations. 

An illustration of the extent to which the profit may be held in un- 
realized form, thus constituting in effect a working capital, is found in 
the current operations of an industrial corporation, the National Biscuit 
Company, which was organized on February 3, 1898, and purchased 
the property of several concerns engaged in the baking business Ac- 
cording to the published report, all the obligations of the constituent 
companies were paid, leaving in the possession of the National Biscuit 
Company current assets to the extent of $3,388,511.00, which constituted 
the working capital of the corporation At the close of business, January 
31, 1903, the current assets amounted to $10,093,366.67, and the current 
liabilities to $739,787.89, leaving a working capital of $9,353,578.78. The 
working capital, therefore, had increased by the sum of $5,965,067.78 
during the five years of operations—a fact accounted for largely by an 
undistributed balance to Profit & Loss Account of $5,294,811.68. 

In nearly all corporate enterprises it will be found that a considerable 
balance to the credit of income must exist before the distribution of cash 
dividends. In the case of a corporation that collects largely in advance for 
its services, as is the case with a railroad company, there will be a small 
percentage of unrealized profit so far as this alone is considered, in compari- 
son with a concern that sells on long time. There are other matters which 
operate to prevent a close distribution of profit even in railway companies, 
which will be considered elsewhere. 


59 


Declaration of Dividends. 


The elements being thus determined from which directors may, in 
their discretion, distribute profits in the form of dividends, the rules that 
govern the actual declaration and payment of dividends, as gathered from 
the decisions of the courts, will be given. 

A shareholder in a corporation has no legal title to the property or 
profits of the corporation until a division is made or a dividend declared, 
and acquires no right or title to the accumulated gains from the revenues 
of the corporation, which entitles him to sue for his aliquot share of divi- 
dends. Until divided by the directors or trustees of the corporation, 
all of his property is held in joint ownership by the corporators, and no 
several right is possessed by the individual stockholder until after a divi- 
dend is declared. The declaration of a dividend, when a surplus has been 
made, rests in the fair and honest discretion of the directors, both as to 
amount and time of payment, uncontrollable by the courts. 

After the declaration of a dividend each stockholder has a right to his 
_ proportionate amount, and this right cannot be abridged by any discrim- 
ination of the directors in any form whatever. 

Dividends are payable to stockholders of record at the time such 
dividends are declared, and it has been held that, until a transfer is 
made on the books of the corporation, as required by the by-laws, the 
corporation will be protected in payment of dividends to the original 
stockholder, assuming that no notice of the transfer has been given. The 
real owner has recourse to the former holder, and not to the corporation. 

It is usual in the larger corporations, especially those whose securi- 
ties are listed on the Stock Exchange, to declare dividends payable to 
stockholders of record on a certain future date, thus giving the owners 
and holders of stock certificates assigned in blank, but not transferred, 
opportunity to make such transfer before the payment of the dividend. 
The transfer books are ordinarily closed by resolution of the board of 
directors for a few days, in order that the dividend list may be made 
up; and purchasers of stock certificates during this temporary closing 
of the transfer books hold their stock in assigned form until the re-open- 
ing of the books. i 

To obtain dividends upon shares, it is not necessary to produce the 
certificate which has been issued for the stock; but the dividends may 
be obtained upon the fact of a recorded title in the company’s books; 
so long as no evidence has appeared from which the right can be im- 
peached or questioned. 

A dividend, unless otherwise provided, is payable only in lawful 
currency or tender. 


60 


Dividends Payable Account. 


After the declaration of a dividend, the amount thereof is trans- 
ferred to the credit of an account under a suitable caption, usually Divi- 
dends Payable. The balance represents a liability, being an amount due 
stockholders; and its collection is enforceable against the corporation the 
same as would be the case with other liabilities. 

The transfer may be made from any account in which net profit, net 
income or surplus is recorded. Thus, the dividend may be charged to 
Profit & Loss Account, crediting Dividends Payable, the balance of the 
Profit & Loss Account being transferred to Surplus. A more usual method 
is to transfer all net profit or income to Surplus Account, charging the 
latter with dividends as declared. It is sometimes the case that a current 
year’s operations do not provide sufficient net profit or income for the 
regular dividend, and the shortage is made up by drawing upon undis- 
tributed net profit or income secured in previous years. Under the method 
of transferring all net profit or income to surplus and charging dividends 
thereto, such a discrepancy between current income and the dividend 
is less in evidence than would be the case were it necessary to transfer 
the shortage from Surplus to Profit & Loss. 

Another method is to transfer all net profit or income to an Un- 
divided Profits Account, against which dividends are charged. Round 
amounts are transferred from Undivided Profits Account to Surplus, a 
sufficient balance being left in the former to equalize dividends in case 
of failure to earn a dividend in any particular year. 

The simplest procedure of all, and one used in many small corpora- 
tions, is to transfer the amount of dividends payable from Profit & Loss 
Account. The latter is allowed to remain in the accounts to measure 
the undistributed profits or surplus, no other account being set up. This 
is not incorrect in corporation practice, for the undistributed profit must 
remain in some account short of the Capital Stock Account. In single 
proprietorship or partnership practice, it would be incorrect to allow 
the Profit & Loss Account to stand open upon the books, it being neces- 
sary to transfer the undrawn balance to Capital. 

Upon payment of a cash dividend, Dividends Payable Account is 
charged and Cash credited, thus closing the transaction. 

A dividend account may be found with a debit balance, caused by 
the payment of profits out of current operations before the formal deter- 
mination of profit and declaration of dividend. Whatever may be said 
as to the wisdom of such a course, the accounting procedure is to con- 
sider it an advance payment on account of Dividends Payable Account, 
the credit to the latter, upon the dividend declaration, applying as an offset. 


61 


Statements Disclosing Appropriation of Income. 


For the purpose of showing the manner in which the appropriation 
of income is handled in practice, statements from two well-known indus- 
trial corporations are given herewith. The forms are not inserted for 
the purpose of criticism, but merely to familiarize the students with such 
statements as they actually appear in the reports. 

The first statement is entitled Summary of Operations, and covers 
the fiscal year ending June 30th, 1910, of the corporation known as the 
American Locomotive Company. This statement is in a condensed, 
although comparative, form. 

The other statement is the Income Account of the United States 
Steel Corporation for the fiscal year ended December 31, 1909, and is 
supplementary to the Condensed Profit & Loss Account of this corpora- 
tion, shown in the preceding lecture. 

The statements follow: 


SUMMARY OF OPERATIONS OF THE 


AMERICAN LOCOMOTIVE COMPANY AnD THE MONTREAL LOCOMOTIVE 
WORKS, LIMITED 


For the fiscal year ended June 30, 1910, as compared with the fiscal year ended June 30, 1909. 


1909-10 1908-09 Increases 

Merete once re TD ce ge wile $32,203.392.10  $19,008,633.97  $13,194,758.13 
Manufacturing, maintenance, and admin- 

istrative expenses and depreciation..... 29,605,443.09 17,665,962.38 11,939,480.71 
PG PTING Oe ae 9 VY nie ew 6 ge 6 we'0'' $2,597,949.01 $1,342,671.59 $1,255,277.42 
Interest. etc., on bonds of constituent 

companies, coupons notes, etc......... 513,190.69 aa Aen o. 157,658.33 
MENU ee 6h, Ss oie oic/e sin eine beter s $2,084,758.32 $987,139.23 $1,097,619.09 
Dividends on preferred stock at 7 per cent. 1,750,000.00 1,750,000.00 
SRM en, idl. po va a ee See ees $334,758.32 $762,860.77* $1,097,619.09 
Net credit to profit and loss............. $334,758.32 $762,860.77 *  $1,097,619.09 


* Deficit. 


62 


UNITED STATES STEEL CORPORATION 
INCOME ACCOUNT 
For the fiscal year ended December 31, 1909 


Total Earnings of all properties after deducting all expenses incident to opera- 
tions including those for ordinary repairs and maintenance (approximately 
$35,000,000), employes’ bonus funds, provisional allowance for corporation 
excise tax, and also interest on bonds and fixed charges of the Subsidiary 


Companies, per General Profit and Loss Account....................eee0- $131,491,413.94 
Less, Allowances for the following purposes, viz.: : 
Sinking Funds on Bonds of Subsidiary Companies......... $1,724,259.65 
Depreciation and Extinguishment Funds.................. 5,884,367.12 
Extraordinary Replacement Funds................... ues 16, 109,687.21 
————__ 23,718,313.98 
Net Earnings in the year 1909.33, 25, .sciphey tae obi rickety aad Vic $107,773,099.96 | 
Deduct: 
Interest on U. S. Steel Corporation Bonds outstanding, viz.: 
Fifty Year 5 percent. (90 Bonts sc). ee $13,987,035.35 
Ten-Sixty Year 5 per cent. Gold Bonds................. 9,630,258.05 
Sinking Funds on U. S. Steel Corporation Bonds, viz.: 
Annual Installment on 50 Year 5 per cent. Gold Bonds... 3,040,000.00 
Annual Installment on 10-60 Year 5 per cent. Gold 
Bonds :'.; 5.3 2,000 ESE CO S Loe Bee? Sie eee 1,010,000.00 
Interest on above Bonds in Sinking Fund............... 1,580,556.60 
———_—————__ 29,247,850.00 
$78,525,249.96 
Add, Credit for premiums received on Subsidiary Companies’ Bonds sold 
and net amount of sundry. adjustments. : . ... sa eve. oe ie 548,445.08 
Total. ...c.ccccsuasduneucesbua bea h baw tap Laue eT een ae, Oe $79,073,695.04 
Dividends for the year 1909 on U. S. Steel Corporation Stocks, viz.: 
Preferred: 
No. 32, 13 per cent., paid June 1, 1909.. $6,304,919.25 
No. 33, 12 per cent., paid Aug. 30, 1909. 6,304,919.25 
No. 34, 12 per cent., paid Nov. 30, 1909. 6,304,919.25 
No. 35, 13 per cent., payable Feb. 28, 
19100 9. SP ee. eee 6,304,919.25 
————————_ $25,,219,677.00 
Common: 
No. 22, 4 per cent., paid June 30, 1909.. $2,541,512.50 
No. 23, 2 per cent., paid Sept. 30, 1909.. 3,812,268.75 
No. 24, 1 per cent., paid Dec. 30, 1909. . 5,083,025.00 
No. 25, 1 per cent., payable March 30, 
1910s os. Siewite ean aes ee eee 5,083,025.00 
Extra, 3 per cent., payable March 30, 
1910. a35 dee ee ale PSs, 3,812,268.75 
————-__ 20,332,100.00 
—————————_ 45,551,777,00 


Surplus Net Income for the year... /. .<64 5 sues eaeewe see ee $33,521,918.04 


63 


Surplus net income for the year, brought forward.............. 00.0. cece eee 
Appropriated from Surplus Net Income for the following purposes, viz.: 
On account of expenditures made on authorized appro- 
priations for additional property, new plants and 


construction, and for discharge of capital obligations... $10,000,000.00 
Specifically set aside for account of construction expendi- 

pues. at Cratyo MCianaA as wants (ooo. do da Si ee eo ere 5,000,000.00 

For Reserve Fund to cover advanced mining royalties... . 3,200,000.00 

Sen SUDO Ole LIC’ VEAL. 9a c ci viehe AG Dad God Mota: oh ve udta ds Sees 

Meee Uris or ecemiper ol. L908 2 ieee. hi vo Coe hie ace hee waldadg vas 


Total Undivided Surplus December 31, 1909, exclusive of capital surp[us 
provided in organization and of Subsidiary Companies’ Inter-Company 
emai ae Wy NN VETICOTIES 2 ius Cob 08 alta i ed ee one Oe Oe an ae 


$33,521,918.04 


18,200,000.00 


$15,321,918.04 
80,079,477.47 


$95,401,395.51 











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ADVANCED THEORY AND PRACTICE 
- OF ACCOUNTS 
ORGANIZATION AND FINANCE 


iy HOMER ST. CLAIR PACK Gs Po As (N. Ye) 


CORPORATIONS—LECTURE VI 


DIVIDENDS.Continued 


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BUTVIDIONT COM BOIS oc hE re MS oh gna une 67 
PeereRnern DIVIDRNIS oO eS 68 
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PREMIUMS ON STOCK........... BAe eieney Seca Whe i 69 
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COPYRIGHT; 1914, BY 
HOMER ST. CLAIR PACE. 


PACE & PACE 


PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


a6 CHURCH STREET, : NEW YORK CITY - 





ADVANCED THEORY AND PRACTICE 


OF ACCOUNTS 
ORGANIZATION AND FINANCE 


Peery Rot: CLALR PAGIGG, Po A (No Y.) 
CORPORATIONS—LECTURE VI 


DIVIDEN DS—Continued 


In General 


The usual and simple condition of the payment of dividends in cash 
has been assumed and treated in the preceding Lecture, although there 
may be legal dividend settlements in other ways, a consideration of which 
will now be undertaken. 


Scrip 


Scrip is a temporary or provisional document, later to be converted 
into that for which it stands. 

Thus, in the absence of cash with which to pay a dividend provision 
may be made for the issue and distribution of scrip, redeemable in cash 
at some future time or upon the happening of some event. The scrip 
may bear interest or not, and will be subject to the conditions imposed 
by its terms. In the accounts, it will appear as an account with a credit 
balance, measuring a liability. The entry will be a charge to Income, or 
to a Dividends Payable Account if such an account has been created; and 
a credit to an account under a caption to indicate its nature, as, for ex- 
ample, Dividend Scrip. 

Instead of a scrip dividend payable in cash, there may be a scrip 
dividend payable in stock or bonds, the securities to be issued later in 
exchange for the scrip. The necessary debit having been made to In- 
come, or Profit & Loss, the Scrip Account would be set up to record the 
liability. This would be closed, and the stock or bond account credited 


upon the exchange later. 
Copyright, 1914, by Homer St. Clair Pace. 


65 


The scrip may be issued on account of an interest instead of a dividend 
payment, and the same rules apply, except that it is a revenue charge, 
instead of a distribution of profit. The scrip itself would appear with 
a credit balance and rank as a liability. 

The scrip may have no reference to a dividend, but may be merely 
a temporary certificate exchangeable later for a formal security. Thus, 
it may represent stock or bonds, exchangeable for the latter when the 
securities are engraved and printed, in which case it is known as stock 
scrip or bond scrip. In the accounts the scrip appears with a credit 
balance the same as the bonds or stock it represents would appear. Thus, 
there may be a certain amount of Preferred Stock outstanding, and, in 
addition, an amount of Preferred Stock scrip, exchangeable for the former. 
An account would be kept for each, but in the Balance Sheet, although 
stated separately, they would be added, and the total carried out to disclose 
the Preferred Stock issued and issuable. 

Scrip is often created to avoid the issuance of fractional shares of 
stock or fractional bonds, when apportionments can not equitably be 
made in even shares or bonds. 

Thus, an association of persons, known as a syndicate, which con- 
structed a large railway improvement in and around Pittsburgh, received 
in part payment an issue of bonds, which were distributed pro rata among 
the subscribers to the syndicate. The bonds were of the par value of $1,000 
each, and scrip was issued for fractional bonds. Thus, if $40,250 in bonds 
were due to a subscriber, he would have received 40 bonds and scrip for $250. 
The scrip was saleable in the market, and as it accumulated in the hands 
of the traders could have been exchanged for bonds—$1,000 of scrip for each 
$1,000 bond. Inthe accounts of the railway the outstanding scrip, although 
stated separately, ranked with the bonds as a liability, 

The issuance of scrip is often avoided, in cases similar to the one 
given, by the sale of securities equal to the fractions, the cash being dis- 
tributed, in lieu of the scrip, together with round amounts of the securities. 

Scrip may be issued to bearer, as is often the case, or it may be issued 
in the name of a person with provision on the certificate for transfer by 
power of attorney. 


Stock Rights 


ft is a general principle of corporation law that a stockholder has 
an inherent right to a proportionate share of an issue of new stock, in 
order that he may protect his interest in the corporation. 

In the case of the issue of new stock by a corporation whose stock 
is selling above par, at a price not above such selling price, the right to 
subscribe therefor may be of value. It is the custom in such cases to 


66 


issue stock rights to the stockholders, in the form of certificates, which 
may be sold and transferred. These rights sell and pass from hand to 
hand prior to the issue of the stock, when they may be presented, with the 
required amount of money, for the issue of the stock. 

The subscriptions may be payable in instalments, and a transferable 
form of certificate and receipt may be issued upon surrender of the right, 
upon which all payments are endorsed. Upon full payment such a tem- 
porary certificate and receipt are exchangeable for the stock. 


Stock Dividends 


A stock dividend arises from the issuance of stock on account of sur- 
plus, in lieu of a cash dividend. Thus, a corporation might have a con- 
dition as follows: : 

I, had od «i witela, So4es $200,000 PAD tau LOCK vache th ok $100,000 


SUT SIS CAN ane cca owl as 100,000 
$200,000 $200,000 


Instead of making a distribution of profits in cash, it may be con- 
sidered better policy to retain all the assets for the use of the company, 
and capitalize the surplus by issuing stock therefor. In this case, a dividend 
at the rate of 100 per cent. would be declared, payable in capital stock. 
Assuming that the issue is authorized and that all legal requirements 
are met, the entry would be a charge to Surplus Account, to close 
it, and a credit to Stock Dividend Payable Account. Upon the issue of the 
stock, the Stock Dividend Payable Account would be closed by a charge, 
and Capital Stock Account would be credited. 

From the foregoing operation, which, although simple, embraces the 
principles involved in stock dividends, it will be seen that the only 
change is that there is $200,000 of capital stock outstanding, with a book 
value equal to its par, while before there was one-half the amount of 
stock outstanding, but having a book value of double its par. 

Such a procedure is really not a dividend payment, in the sense that 
a dividend is a distribution of assets as profits, for all the assets of the 
corporation are retained. It is, rather, a dilution of the book value of 
the capital stock, and amounts, if for 100 per cent., to giving the share- 
holder an additional share for each share of stock owned, the two shares 
representing the same intrinsic value that was represented by the one 
share before the stock dividend. 

There are several contingencies that may lead to the declaration 
of a stock dividend. Usually it comes from the desirability of retaining 


67 


the capital in the business, and formally converting it so as to settle all 
questions as to its distribution. The stock thus acquired may usually 
be marketed and thus converted to cash, although this would reduce the 
proportionate holding of the individual stockholder, and affect to that 
extent his voice in the control of the corporation. It may happen, 
however, that the aggregate market value of the new and old stock is 
greater than the value of the old, although the intrinsic values are the 
same. If so, and the profits are realized, a profit is achieved by the book- 
keeping operation. 

It has been desirable, in some classes of corporations, not to earn 
and distribute a profit beyond a certain rate. The stock dividend pro- 
cedure has been used to produce the effect of a higher rate by providing 
a larger stock basis upon which to declare cash dividends. 

It often becomes necessary to determine whether a stock dividend 
is income or principal. Thus, if the original stock were held for the 
interest of one person, and the income paid to another, the determination 
would vitally affect their respective rights. The decisions are conflicting, 
although the trend now seems to be in favor of treating such a dividend as 
principal, upon the theory that it amounts, in fact, to a retention, rather 
than to a distribution, of profits, despite the apparent intent on the part of 
the directors in calling it a dividend, to make it a profit distribution. There 
are recent decisions, however, that hold that stock dividends are income. 


Dividend Checks 


A voucher check is one that carries upon its face or attached a state- 
ment of the items for which settlement is made by its amount. The use 
of the check constitutes a receipt for the items specified. Its general 
use is restricted by the objection of banks to deviation from the standard 
forms and sizes of checks, without which the details, in many cases, can 
not be fully stated. There may be objection, in certain lines of business, 
to the publicity thus given to the details. 

In the case of the payment of a dividend, however, these objections 
do not have weight, and it is desirable to have stated upon the face of 
the check the fact that it is a payment of dividend. The form may vary 
from a stamp stating merely ‘“‘ Dividend No. 10,” to a special form of 
check, such as that used by railroad companies, specifying that it is in 
payment of ‘‘ Dividend No. 10, being 6 per cent. upon 100 shares of Pre- 
ferred stock standing in the name of, etc.’’ The fuller the information, 
the better the form will be. In the case of the stockholders being numer- 
ous, there are likely to be cases in which it is alleged that a dividend, 


68 


payable perhaps months or years before, was not received. In such a 
case it is advantageous to have a paid check, endorsed by the payee, and 
specifying upon its face the exact dividend which it paid. The use of 
the check relieves the corporation from the necessity of mailing a letter 
with the check, and the stockholder oat any acknowledgment other nba 
the use of the check. 

In some corporations, it is the practice to advertise the payment 
of the dividend upon a certain date, payable upon application at the 
office of the company or its banker. In the large corporations, where 
this custom is followed, it is usual to mail checks if a mailing order is 
filed. The custom of mailing all dividend checks is becoming general 
among the large corporations. 


Preferred Dividends 


A class of stock, by provision in the certificate of incorporation, 
may be entitled to a preference over some other stock or stocks, either 
as to the distribution of assets upon the dissolution of the corporation, 
or in the distribution of income, or in voting rights. A stock that is pre- 
ferred as to distribution of profit will not be preferred in the distribution 
of assets or in voting powers, unless there is an express provision to that 
effect. 

The preference as to the distribution of income or dividends may be 
cumulative at a certain rate; that is, in the absence of the distribution 
at the stated rate, the right of the holders of such preferred stock to a 
prior distribution of profit will accumulate in their favor. Thus, the 7 
per cent. Preferred Stock of the United States Steel Corporation is cumu- 
lative, and if the corporation did not earn and distribute 7 per cent. per 
annum upon the stock, there would accumulate, annually, in favor of the 
holders thereof, an amount equal to 7 per cent. of the par of their stock. 
Such an accumulation is not a liability of the company in the sense that it 
is an amount that will have to be paid, but it does measure, in favor of 
one class of stockholders, a priority in the distribution of profits when 
earned. Such an accumulated preferred dividend should not be shown 
on the Balance Sheet, either as an actual or contingent liability, but it 
should be shown thereon as a memorandum, for the information of stock- 
holders, in order that their respective rights may be set forth. It may 
be contended that it is a contingent liability, becoming actual upon the 
earning of a net profit. There is the substantial difference, however, 
that the ordinary contingent liability, when it becomes actual, is not de- 
pendent upon a surplus of assets over liabilities and capital, but ranks 


69 


with the other liabilities. The dividend liability is dependent upon such 
a surplus, and is, therefore, a matter of interest to the stockholders rather 
than to the ordinary creditors. 

A dividend may be preferred to the extent of being payable out of the 
income of any year before the declaration and payment of a dividend 
upon some other class or classes of stock, without being cumulative. In 
such a case, a dividend upon the preferred stock is a prerequisite to the 
declaration of a dividend upon the stock not preferred. Thus, a corpo- 
ration might have two issues of stock, one upon which a 6 per cent. preferred 
dividend must be paid out of any year’s income, before the declaration 
and payment of a dividend upon the common stock. 


Prior Deficits 


The situation is often found in which a corporation has made losses 
and subsequently earns a net income. The question then arises whether 
it is necessary for the corporation to restore the assets of the Company 
to such an extent as would be necessary to wipe out the losses before the 
declaration and payment of a dividend. 

The law and the decisions upon this subject are not clear. ‘There is 
a line of cases which hold that a dividend is payable only out of an excess 
of asset value over combined capital stock and liabilities. If such decisions | 
controlled, it would be necessary for a corporation to make up its losses or 
deficits before the payment of a dividend. 

There have been other decisions which indicate that such prior losses 
are considered as capital losses of the year in which they occurred, and 
that their recoupment from operation is not necessary, although this doc- 
trine is not so well settled that it can be stated absolutely. 

So far as conservative accounting practice is concerned, there can 
be no question that the position of the Company should be restored to a 
place where the excess of asset value, fairly stated, over the amount of 
liabilities, after the payment of a dividend, should be at least equal to the 
amount of capital stock issued and outstanding. That is to say, there 
should be a surplus in the accounts at the time of the declaration and 
payment of a dividend at least equal to the amount of such dividend. 


Premiums on Stock 


The capital stock of a corporation may be sold legally at an amount 
in excess of its par value, and it seems to be clear that such excess con- 
stitutes a technical profit that may, in the discretion of the directors, be 


70 


distributed as dividends. Such a profit, however, should not be confused 
with the results of trading or operation, but should be stated separately. 
The ordinary and conservative practice is not to distribute such a surplus, 
but to hold it for the benefit and use of the corporation. 

In the organization of banks and trust companies, it is not unusual 
to find that the capital stock is paid in at an amount in excess of its par 
value, and frequently at double the amount, so that the Company may start 
with a surplus equal in amount to its capital stock issued and outstanding. 


Distribution of Capital by Dividends in Mining Companies 


There is an exception to the general rule of corporation law forbidding 
the distribution of the capital in the form of dividends, in the case of 
companies organized to work out a mine, patent, or similar wasting asset. 

Thus, if a corporation is organized to operate a particular mine, and for 
no other purpose, there would be no need for withholding from the stock- 
holders the portion of the current returns that represents capital, and it 
could be distributed as a dividend, so called. This is subject, of course, to 
the previous provision for all liabilities. 

It would be otherwise, in accounting practice at least, were it the 
intention to continue the corporation to operate other properties, for in 
that case it would be necessary to keep the capital intact. This result 
could be accomplished by reserving from the proceeds of each ton pro- 
duced, an amount equal to the cost of the ton of unmined ore. This 
amount could be arrived at by dividing the cost of the mine by the tons it 
is estimated by the engineers to produce. It is true that this procedure 
may be accompanied by many difficulties, but, by conservative action, it 
is usually practicable to carry it out in such a way as to preserve the capital. 


Donated Stock 


The treatment of donated stock, and the transactions that arise in 
connection therewith, may involve an improper creation of a surplus 
account, and therefore will be considered in this Lecture. 

Under the New York law, and under corporation laws in general, 
the stock of a corporation cannot be issued lawfully, in the first place, 
at a discount—that is, at less than its par value. It is probable that, as 
between the corporation and the stockholder, the stock could be sold 
legally at a discount; but as between such stockholder and the creditors 
of the corporation, in the event of failure to collect from the corporation 
the latter would have recourse against the stockholder for the difference 
between the purchase price of the stock and its par value. 


71 


Few purchasers would be willing to assume such liability, and there 
is thus constituted a serious stumbling block in the way of promoters 
or others who desire to organize corporations for the development of 
patents, mines, or other uncertain undertakings, and who plan to sell stock, 
at whatever price it may bring, to provide the funds with which to develop 
the undertaking. 

The manner in which this question may arise in practice is set forth 
in Problem No. 1, Practical Accounting, in the New York C. P. A. Examina- 
tion held in June, 1900, which is as follows: 


‘It is proposed to organize for conducting a manufacturing 
business a small corporation based on certain rights and fran- 
chises owned by one of the proposed stockholders in the corpora- 
tion. The amount of the capital is to be $100,000. The owner 
of the rights and franchises agrees to transfer them to the cor- 
poration in consideration of $50,000 of the capital stock, though 
he believes them to be worth much more than that amount. 
Certain capitalists are to be approached for cash subscriptions to 
the capital stock, but it is uncertain what opinion they will hold 
concerning the enterprise, and it is desired to have the stock in 
the treasury in such form that it can be sold below par if necessary. 
What method would you suggest for accomplishing the object 
in view? Formulate the Journal entries for opening the cor- 
poration books.”’ 


If the owner of the rights and franchises believes them to be worth 
much more than $50,000—say, to be specific, that he believes them to 
be worth $100,000, and the directors of the corporation concur in this 
judgment, the corporation could take them over on that basis, and issue 
its total authorized capital stock of $100,000 therefor. 

The former owner, being, in the first place, willing to take $50,000 
for his rights and franchises, in order to further the development of the 
undertaking he would be willing, no doubt, to donate one-half of his 
holdings, or $50,000 of stock, to the treasury of the corporation, to be 
sold to provide the necessary funds. He might well believe that his remain- 
ing $50,000 of stock would have greater value with such development 
than the entire $100,000 of stock would have without such development. 

Inasmuch as stock originally issued for its par value may, if it sub- 
sequently comes into the treasury of the corporation, be sold for any 
price that it may bring, the procedure indicated would meet the require- 
ments of the problem. | 

Assuming that this method is adopted, and that the donated stock 
is sold at fifty cents on the dollar, the following entries illustrate the prin- 
ciples of debit and credit necessary to record the transactions, viz. : 


72 


SUNDRY RIGHTS & FRANCHISES...... $100,000 
2G BLANKS Vendor. «. i064 ase naan GA $100,000 
For property acquired. 


Pree CUOtE ates 1k iin ne mae, $100,000 
Cor Mas VICK culicbare bas od, $100,000 
For payment of balance due in stock. 


PRCT Ue LOC ee PE ead ae Pe $50,000 
moma LOCK DONATION: 2 eee: $50,000 
For donation. 


Sa5 TREASURY SPORK 3 2) pulser. $50,000 
For sale of stock. 


melee DONATION 20.5049 sees ai ea Oe $25,000 
To DISCOUNT ON SALES OF TREAS- 
(aT a hs TE a nla $25,000 
For transfer. 


rma IC MTR LOIN akc peti ae ss a 6's $25,000 
To SUNDRY RIGHTS & FRANCHISES. $25,000 


For transfer. 
A Balance Sheet of the corporation, prepared after the foregoing 


entries were carried into effect, would appear as follows: 


THE BLANK CORPORATION 


Batanceroneet. as atic. > seteee ede he 


ASSETS LIABILITIES 
Sundry Rights and Franchises. $75,000 Capital Stocks. i... $100,000 
Rr ces oP euaae a". « « 25,000 


$100,000 $100,000 


The Balance Sheet evidently discloses the true state of affairs, for 
the corporation has, in fact, acquired two items of assets in exchange 
for its stock issue, viz.; Cash, to the extent of $25,000, and Sundry Rights 


73 


& Franchises, which is fairly chargeable with the difference, $75,000. 
It should be noted that the facts are recorded at each stage of the procedure. 

While, for the sake of clearness in explaining the most important 
points in the foregoing problem, round amounts have been used, in 
practice it would necessarily happen that there would be at least three 
incorporators to whom stock would be issued, and this would have to be 
shown in the opening entries. It is customary in such cases to issue at 
least five shares of stock at par for cash, although it is not necessary that 
the shares be paid for in cash. 

A method that is used to a considerable extent is carried out by 
making no entry whatever when the stock is returned to the treasury. 
When it is sold, an entry is passed debiting cash and crediting the property 
account, or possibly an account under the caption of Proceeds of Donated 
Stock, this latter to be credited to the property account at a later date. 
The objection to this procedure is that no record is made in. the financial 
books when the stock is returned to the Company. This objection is 
overcome to some extent, however, by the fact that the donation is usually 
made a matter of record in the Minute Book. 

An erroneous procedure is sometimes carried out by which a Surplus, 
or Working Capital, account is set up when the stock is donated to the 
Treasury and credited, Treasury Stock being debited. 

Against this so-called Surplus, or Working Capital, account, the 
discount on stock sold is charged. If this method had been adopted in the 
problem under consideration, the Balance Sheet would have been as 
follows: 


Incorrect Solution 


THE BLANK CORPORATION. 


Balance Sheetiae ar. eee 


ASSETS LIABILITIES 
Sundry Rights & Franchises.. $100,000 Capital Stock (48 $100,000 
Cash (Ob 2 22.0 ink Ge ga 25,000 Surplus (or Working 
Capital) ieee 25,000 
$125,000 $125,000 


This procedure is supported on the ground that, if the Sundry Rights 
& Franchises are really worth $100,000, there is an increase in capital 
to the extent of the amount of stock donated, and that against this should 


74 


be charged any discount, resulting in a net amount of Surplus or Working 
Capital. 

The objection to this procedure is that there is no profit out of which 
to create Surplus. The whole operation is undertaken to place the stock 
in the treasury in such shape that it may be sold at a discount, and the 
creation of a nominal profit or capital out of the transaction is, in nearly 
all cases, likely to create wrong impressions as to the financial condition 
of the corporation. 

The consideration of Donated Stock has been necessary owing to the 
frequency with which it arises in practice. It is a transaction open to 
some legal doubt, and the accountant should proceed with the approval of 
the counsel of the corporation. 


Illustrative Balance Sheet and Profit and Loss Account 


The Balance Sheet of the Anaconda Copper Mining Company, as at 
December 31, 1909, and the Profit and Loss Account of the same company 
for the year ending December 31, 1909, are appended, for the purpose 
of placing before the student examples for study. 


75 


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ADVANCED THEORY AND PRACTICE 
.. “OF ACCOUNTS. 
ORGANIZATION AND FINANCE. 


By HOMER ST, CLAIR PACE, C. P. A. 
- CORPORATIONS—LECTURE VIL. 


FUNDS AND RESERVES. 


DEFINITIONS AND DISTINCTIONS...... egal Rar kat oO eg arth 9 SUS 77 
aR GOUT es ais oe OM ee i a ee SE et 70 
PE ey Nu A us aah IRL OAL Woy ate Fiat 79 
Ree aay FOR Osshe ote er oe a ye 80 
eee BCPA V ES oe TSU Re ay Do pice aunt We piace Si 
- Sinkine Funps.......... UE Rear on ed Ras WR CU Ree soial a NS Saas DNS 81 
BryeInG FUND ENTRIES Solo oh een. Se ane eg or eae 
Sinkinc Funp ILLusTRATION....... Ore Ne i ean dea et Nace! 84 
Marein, Rest, Dt a CAE OU CONE Rai ea Can ge NA TRS RN a neat 86 
Peerntne UPON LIISSOLAITION Vie chy civ vue eid ee ea kie s caalinks, pte 87 


CoPYRIGHT, 1912, BY 
Homer St, Clark Pace, 


\, A y 

We Bi?) te + 

CPR ER, Meter eran 
Lo ay tethers 


ra 


a dies & 
A ate 





ADVANCED THEORY AND PRACTICE OF 


ACCOUNTS, 
ORGANIZATION AND FINANCE. 


By HOMER ST. CLAIR PACH, C., P. A. 
CORPORATIONS—LECTURE VII. 


FUNDS AND RESERVES. 


Definitions and Distinctions. 


The use of the term fund is common and proper whenever it is neces- 
sary to distinguish certain assets, associated for a purpose, from all other 
assets. Hence, a fund may be defined as a stock or accumulation of 
assets, either money or convertible wealth, brought together for a par- 
ticular purpose. 

The property and property rights belonging to an individual, or to 
an organization formed for the production or conservation of values, 
constitute a fund, the assets of which are segregated from all other assets 
and distinguished as belonging to the particular fund. Without thus 
providing for the identification of the assets the rights of creditors and 
proprietors could not be defined and safeguarded. 

The assets of a corporation constitute the corporate fund and are 
used in carrying out the objects of the corporation. A portion of the 
assets may be contributed as capital by the stockholders, while in many 
cases a considerable portion of the entire fund is loaned or advanced by 
creditors. The fund is the entire stock of assets, whether invested as 
capital or advanced as loans, and it may be subdivided in various ways. 
For example, certain assets may be segregated and held for the purpose 
of liquidating a financial obligation, or for the purpose of making a certain 
improvement to the permanent plant. In this way assets are associated 
within the corporation for particular purposes and funds created. 


Copyright, 1912, by Homer St. Clair Pace. 


78 


In order to make clear the relation of a special corporate fund to 
the general fund, the following form of balance sheet, arranged especially 
to present the condition, is submitted: 


ASSETS. CAPITAL AND LIABILITIES. 


Assets (general fund)..... $175,000 Capital Stock... 157s $100,000 
Assets (fund for payment SNIPEIMSS sue cL ee eee 50,000 
of liabilities) sae es 25,000 Liabilities. ; 4a 50,000 


$200,000 $200,000 


The entire corporate fund is $200,000, although the intention is 
evident to hold $25,000 of assets in a special fund, available for the pay- 
ment of liabilities. The sources of the funds are shown on the right side. 

The use of the term fund, as has been indicated, is not limited to 
corporation practice. It may as well be applied to any stock or accu- 
mulation of assets, irrespective of the form of business organization hold- 
ing title thereto. 

Thus, the contribution of money and articles of value without 
formal organization for the use of an indigent family, constitutes a fund 
that may be designated as a relief fund. | 

A fund may be temporary in its nature, as in the case of a building 
fund, which ceases upon the completion of the building for which it is 
created; or it may be permanent in its nature, as in the case of a main= 
tenance fund, created for the upkeep of a building after its completion. 
The latter may be divided into principal, or the part that constitutes 
the body of the fund, and income, the part that is derived from the use 
of the principal, and that may be expended without impairing the fund 
proper. 

The fund may be a trust fund, that is, a fund held by one, known 
as a trustee, for the benefit of another, known as a cestui que trust, or 
beneficiary. 

The fund may be gradually built up by setting aside principal sums 
and by the accumulation of interest thereon, in which case it may be 
known as a sinking fund. Hence, a sinking fund is defined to be a 
gradual accumulation of assets, by a governmental body or private enter- 
prise, for a particular purpose, most frequently the payment of a loan 
upen its maturity. 

The creation of funds is essential to the production and conservation 
of values, and their treatment, therefore, will be necessary throughout 
all accounting. . 


79 


In this lecture, it is proposed to consider in particular funds common 
to the corporate form of business organization. 


Fund Accounts. 


An account is a collection, under a distinctive caption, of the debits 
and credits pertaining to a particular person or subject. Thus, it may 
be a ledger record of the debits and credits relating to a person, to an 
asset, or to some phase of a business, or it may be a document apart from 
books of account, formally setting forth, for a period of time, a series 
of financial demands or claims, with their offsets, of one person against 
another. All financial transactions of an enterprise are recorded in accounts. 

The establishment of a fund is a transaction, or a series of tran- 
sactions, having to do with asset value. Funds always consist of assets 
and can, in no instance, be dissociated therefrom. Inasmuch as assets 
appear, throughout all accounting upon the double entry basis, as debit 
balances, it follows that funds, likewise, must appear with debit balances. 

Capital consists of assets, but in double entry accounting the credit 
balance that is designated Capital, merely measures the asset value 
contra. In corporate practice, the accounting capital would be the amount 
of capital stock issued and outstanding, plus any undistributed profit or 
surplus, or less any deficit. In the case of a surplus, the intent to with- 
hold a portion thereof from distribution and to accumulate assets in some 
particular form to the extent of the amount of such withheld profit, might 
be evidenced by a transfer from the surplus account to a special account. 
The amount thus set aside in a special account would not be a fund, but 
it might show the intention to create a fund. The fund when created 
would appear in an account with a debit balance, measuring the actual 
assets associated for the purpose of the fund. 


Reserves. 


A reserve is something held back for the present. The term is ap- 
plied, in Accounting, most frequently to the withholding of some part 
of the credit balances that represent profit. Thus, when there is an 
intention expressed by the directors to withhold from distribution any 
part of the undistributed net profit, such action may be shown by an 
account under a caption that indicates the facts in the particular case. 

The subject of income has been treated at length in preceding lec- 
tures, and it will be taken for granted that the student has in mind the 
classes of expenses and losses, direct and indirect, that are properly charge- 
able against income before arriving at the net income or surplus out of 
which lawful dividends may be declared and paid. 


80 


The element of surplus, when not distributed in dividends, may be 
left in a Surplus or similar account without definite action by the board 
of directors, or it may be formally appropriated. In case a reserve of 
profit is made, not for a definite purpose, but merely to indicate the inten- 
tion to withhold surplus from distribution for the general good of the cor- 
poration, the term Reserve may be used as a caption for the account to 
which the amount is transferred. It differs from surplus only in the ex- 
pression of intention as to distribution. 

The appropriation may be for a particular purpose. Thus, it may 
be made for the betterment of assets, as a conservative and precautionary 
measure, even though full allowance has already been made for depre- 
ciation. The account to record the amount thus set aside may be called 
Reserve for Betterments. 

It must, in the first place, be thoroughly understood and appreciated 
that the credit balance to surplus, or other profit account, is not, in itself, 
a profit. The real profits exist in the assets on the other side of the accounts, 
the amount of which is measured by such credit balance. Therefore, 
in transferring an amount from Surplus to Reserve for Betterments, no 
fund, in the sense that a fund is a collection of assets collected or set 
aside for a specific purpose, is created. All of the assets are, in a general 
way, a fund for the purposes of the corporation, but from the general 
fund no specific fund is created for betterments by the transfer from 
Surplus. A fund for betterments could be created only by setting aside 
and ear-marking specific assets. However, the appropriation and transfer 
from Surplus to Reserve for Betterments is a formal withholding of profit 
from distribution, and may be taken as an evidence of intent to expend 
upon betterments an amount equal to such appropriation. In fact, such 
action is often taken after the net income or surplus has been expended 
in betterments and additions, in order to confirm such expenditures. 

It would be improper, for the reasons given, to designate such a 
transfer from Surplus as a fund, and the reasoning applies to all similar 
appropriations and transfers. The fund, if created, exists on the asset 
side of the accounts. 

Reserves for Losses. 

The term reserve is often used in a different sense. It will be recalled 
that such indirect expenses as depreciation on fixed assets, and estimated 
losses on the realization of current assets, are proper charges before the 
determination of netincome. In order to retain cost values in the accounts, 
and for other reasons, the fixed asset is not written down by the amount 
of the allowance for depreciation, but a Reserve for Depreciation is set up. 

So also, in the case of provision for estimated losses in the collection 


=) 


of accounts receivable, the custom is to charge the Profit & Loss, or In-. 
come, Account and credit an account called Reserve for Bad Debts. The 
reason for the creation of such an account is that the accounts in which 
the losses will occur are at the time unknown, and it is necessary to set 
aside, or reserve, a portion of the credits equal in amount to such expected 
loss, in order that the element may be held available to write down the 
asset account when the exact amount and location thereof are known. 

The cases cited are not true reserves, but are merely offsets to losses 
that exist or that are expected to become actual, but which it is not yet 
practicable to write off. 50 an estimated part of income (not net income), 
is held available to meet such losses when it becomes feasible to write them 
off. If the estimate is too large, then to the extent of the overestimate a 
real reserve, or profit, exists that may later be transferred to Surplus. If 
the more unfortunate situation of an underestimate exists, it will have to 
be made good from later periods, or from Surplus. y 

To avoid confusion, such accounts should, in their caption, state 
the exact purposes for which they are created. In the Balance Sheet 
they should be deducted from the respective assets for which they are 
created, and should not be carried to the liability side. In particular, such 
accounts should not in any way be confused with true reserve or surplus. 


Secret Reserves. 


In some instances, corporations, particularly financial institutions, 
understate asset values, thus creating a so-called secret reserve. One of 
the purposes of this is to render uniform the earnings or profits, by 
drawing upon such secret reserves in times of business depression, leay- 
ing the Reserve or Surplus, formally set aside, intact. 

This practice is wrong in theory, as there is no more justification 
for understating asset values than for overstating them. It is, perhaps, 
needless to point out that the accountant is more frequently under the 
necessity of protesting against the latter than the former practice. 

It is the custom of some institutions to omit the value of their bank- 
ing house and fixtures from the Balance Sheet, stating, however, the 
name of the asset and carrying to,the money column the word nil. This 
is doubtless better than omitting it altogether, as it serves notice that 
asset values exist that have not been taken into account. 


Sinking Funds. 
A sinking fund may be created by the gradual conversion of assets 


into the form adopted for the particular fund without reference to the 
profits of the corporation. If this were done and the sinking fund created 


82 


for the purpose of meeting an obligation at its maturity, it could be used 
for that purpose and the procedure would merely be the extinction of a 
liability by assets gradually accumulated and held for that particular 
purpose. 

A sinking fund may be created from assets appropriated for that 
purpose from profits. Inasmuch as a liability, theoretically, is payable 
out of assets other than those secured as profits, there is no accounting 
reason why net income or profits should be withheld from distribution for 
the purpose of providing a fund to meet the liability at its maturity. 
It is obvious, however, that if, in addition to the general assets of the 
undertaking, a part of which are secured through the incurrence of the 
liability, further assets are accumulated through the retention of profits, 
there is added financial strength and greater protection to the creditors. 

In case an obligation is secured specifically by mortgage upon a 
wasting property, as might be the case in a mining company where the 
capital assets are reduced by the extraction and sale of the mineral, the 
sinking fund plan may be used to accumulate from the income an amount 
sufficient to render certain the payment of the liability at maturity. This, 
strictly, is not the accumulation of a fund from withheld profits, but the 
accumulation of a fund from returns to keep intact the assets and to 
prevent the distribution of capital in the guise of dividends. Thus, if 
the payment of a debt were secured by a mortgage upon coal lands, a pro- 
vision might be necessary that required a certain amount, equal at least 
to the cost value of the coal, to be retained from the income received 
from sales of coal, and placed in a fund for the benefit of creditors. 

The creation of a fund, for which assets are ear-marked and set aside, 
whether out of profits or not, does not necessarily, without the creation 
of a specific lien thereon, insure the payment of an obligation. So long 
as the assets are under the control of the undertaking, and subject to its 
vicissitudes, losses in other assets will eliminate the reserve for sinking 
fund, and possibly necessitate the use of the sinking fund assets for the 
general purposes of the concern. 

Hence, when the sinking fund is created for the protection of a 
creditor, and not merely as a convenience for the one creating it, it is 
ordinarily required that the sinking fund be in the hands of a trustee, 
most often a trust company. In this way it is pledged for a particular 
purpose, and is removed from the fund that is available for the payment 
of unsecured creditors. 

It is important to bear in mind that all appropriations or reserves 
from profit depend, for their integrity, unless the assets represented 


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thereby are taken out of the control of the corporation, upon the 
accounts as a whole, and losses that bring the assets, fairly valued, to a 
point where they do not exceed the combined amount of the liabilities 
and capital stock, eliminate every such appropriation from Surplus. 
Therefore, from the viewpoint of the interested creditor, the only satis- 
factory sinking fund is the one beyond the control of the debtor, pledged 
for the benefit of his claim. | 


Sinking Fund Entries. 


In case a sinking fund is created by the mere conversion of assets from 
one form to another form, without reference to profits, the entries would 
provide for charging the sinking fund account, or accounts, with the assets 
belonging to the fund and crediting the accounts from which such assets 
were transferred. If the sinking fund assets were augmented by interest 
accretions received on such assets, the income would be merged in the 
ordinary income account, for the reason that the accumulation of the 
fund bears no relation to profits. 

In case the fund is created out of profit assets, it would be necessary 
in the first instance to transfer the amount to be set aside from net income 
or surplus to an account created to show the appropriation of profit. Inas- 
much as it is profit held back for a time, for sinking fund purposes, the 
account may properly be called Reserve for Sinking Fund. This account 
will then measure the amount to be withheld from profit for the purpose 
of the sinking fund, and in a statement to disclose the financial condition, 
it would be stated in an indent column as a distinct item, but merged 
with unappropriated surplus in the total column to show the entire amount 
of surplus in the corporation. 

The creation of the fund proper will then proceed by the conversion 
of assets to the form required in the sinking fund, in the same manner 
as before stated. If the sinking fund is in the hands of a trustee, the 
ordinary procedure is to pay the trustee an amount of cash equal to the 
appropriation from net income or surplus. If the sinking fund is brought 
to the proper amount, it will equal the Reserve for Sinking Fund shown 
with a credit balance. If it is less than the appropriation, there will still 
remain an amount of assets to be converted to the sinking fund basis. 

Interest accretions, whether collected by the corporation or the 
trustee, would increase the amount of the fund, and could be credited 
either to the Reserve for Sinking Fund or to a special sinking fund income 
account, later to be transferred, after deducting any possible costs or 
charges, to the Reserve for Sinking Fund Account. 


84 


Sinking Fund Illustrations. 


A bond, as will be explained more fully in subsequent lectures, is a 
written agreement to pay to bearer, or to some person, or order, a 
certain sum of money at some future determinable time, the payment 
of which is, in most cases, secured by a mortgage or trust deed upon 
real property, and, in some cases, upon personal property as well. The 
interest is payable according to the terms of the bond, usually quar- 
terly or semi-annually. In case of failure to pay the interest or the prin- 
cipal of the bond at maturity, a trustee, designated in the mortgage secur- 
ing the bonds, is empowered and obligated to foreclose the mortgage or 
trust deed and dispose of the property for the benefit of the claims of the 
holders of the bonds. 

The mortgage or trust deed, in many cases, provides that the com 
pany issuing the bonds shall, as additional security, withhold each year 
from its net profits a certain amount, which shall be turned over to the 
trustee, to be held, with or without interest accretions, for the payment of 
the bonds. In some cases, a certain proportion of the bonds are drawn 
each year by lot and are retired out of the funds thus in the hands of the 
trustee, or, the funds may be held, with interest accretions, until the 
maturity of the bonds, when the entire issue is redeemed. 

A case may be assumed in which, by the provisions of a trust deed, 
a company must pay, for a period of twenty years, the sum of $25,000 
from profits each year, to a trustee, which is to be invested in securities 
of the class authorized by law for savings bank investments. The interest 
received on such securities to is be added to the fund, and together with 
the principal of the fund, is to be used in the payment of the bonds at 
maturity. 

In some cases the securities purchased under the provisions of the 
agreement were bonds bought at a premium, that is, an amount in excess 
of face value. Inasmuch as the bonds would be payable at maturity at 
par, the value of the bonds would have to be written down proportionately 
each year against the nominal interest return that was received therefrom. 

The entries necessary to cover the foregoing transactions for a term 
which involved the setting aside of $25,000 for the fund, the purchase of 
securities, receipt of interest, etc., would be as follows: 

SURPLUS. ae ack oe Au ee Dee oe a oe 
To RESERVE FOR’ SINKING FUND. ..: 0. eee 


This entry is necessary to indicate in the books of the company the 
formal reservation from distribution, for a certain period, of the sum 
which is agreed to be turned into the fund out of profits. 


85 


This entry is necessary to record the actual payment of money to 
the trustee as required under the agreement. The amount is thus placed 
in the hands of a third party, which safeguards it against losses that the 
company might incur in other directions. 


SINKING FUND SECURITIES WITH TRUSTEE...... 
For bonds purchased at par. 
paovwluUM ON SINKING FUND BONDS..........04.% 
For premium on bonds purchased. 
To SINKING FUND TRUSTEE, Cash Account...... 


If, in the books of the company, it were desirable, as it no doubt 
would be, to keep an exact record of the transactions of the trustee, it 
would be necessary on receipt of information from the trustee, to pass 
entries setting up the securities purchased for the purpose of the fund, 
either in a general account or in separate accounts. Inasmuch as the pre- 
mium would be written off, either at once or gradually, against the income, 
it is taken into a distinct account. 


Pee ING PUND TRUSTEE, Cash Account............. 
Peel Gre AN) IRE VIEN UE og oe ele ee eet 


The above entry would be passed, upon information received from 
the trustee, to record the receipts on account of interest on securities 
held for the fund. The cash would augment the cash received from the 
corporation on account of the yearly payment, and would be available 
for the purchase of further securities. 


Be taNGOEUND REVENUE 2!) soleleny SEY, 
To PREMIUM ON SINKING FUND BONDG...... 


The foregoing entry would be necessary to charge off against the 
revenue account the proportionate amount of the premium. A still more 
conservative measure would be to write off immediately from the revenue 
any such premium, although in theory such charges should be distributed 
over the life of the bond. 

A change in the procedure might be the purchase of the bonds of the 
corporation for which the sinking fund is created, instead of other securi- 
ties. This is a matter that would be governed by the agreement in the 
particular case and does not affect in any way the principles involved. 

Finally, in the case assumed, before the retirement of the bonds for 
which the sinking fund is created, the securities in the hands of the trustee 


86 


would be reduced to cash, and if sufficient to retire the bonds, an entry 
would be passed as follows: 
BLANK .MORTGAGE BONDS... .:....2.). 4.04 seen 
To SINKING FUND TRUSTEE, Cash Account..... 


If the funds were not sufficient, the balance would have to be made 
up by the corporation. 

The net effect of the whole transaction is to give an added security 
for the payment of the bonds through a certain amount of profit being 
withheld from distribution among stockholders, which is rendered particu- 
larly effective by its withdrawal from the general fund of the corporate 
assets and its deposit in the custody of a trustee. 

During the sinking fund operations, the two credit balances arising 
would be stated as Reserve for Sinking Fund and Sinking Fund 
Revenue. These amounts would represent surplus if they were properly 
created out of net profit, but would differ from ordinary surplus if there 
is an agreement that provides that, to the extent of the balances of 
these accounts, profit shall not be distributed. There is therefore, justifi- 
cation for displaying these facts in the accounts stated, although the two 
should be added to the total of unappropriated net profit or surplus to 
obtain the grand total that discloses the undistributed profit. 

The credit balances of profit held from distribution during the sinking 
fund agreement are released by the payment of the bonds, and, being an 
element of surplus or undistributed profit, the accounts should be closed by 
a charge to each and a credit to surplus. A better procedure, perhaps, 
would be to transfer it back to Profit & Loss, or Income, from whence it 
came, and then to transfer the amount to Surplus. 

During the operation of the sinking fund, the sinking fund accounts 
proper with debit balances, consisting of securities, cash, etc., should 
equal in amount the accounts with credit balances, and their display in 
opposition would be effective in balance sheet construction. They would 
then show on the right side the sources of the fund and on the left side 
the state of the fund as to the character of its assets. 


Margin, Rest, Etc. 


The element of surplus may be recorded in the accounts under many 
names. Thus, the words margin and rest are used in this connection. 
Enough has been said to enable the student to determine the element 
and to treat it according to accounting principles. 

Funds may be stated under various captions. Thus, assets are 
often accumulated in a Redemption Fund for the retirement of a liability, 


87 


which does not differ essentially from a sinking fund. Likewise, the term 
Investment Fund is sometimes found in use, to denote an aggregation of 
assets held for investment purposes. 


Entries upon Dissolution. 


Upon the dissolution of a corporation, the legal formalities having 
been complied with, it is first necessary to liquidate the liabilities. 
The remaining assets are distributed pro rata among the stockholders 
of record. 

Capital Stock Account remains a fixed amount throughout the life 
of a corporation, and it is not permissible to carry thereto any profits 
or losses. Inasmuch as in the realization and liquidation of a corpo- 
ration there is almost certain to be a surplus or a deficit, it is considered 
best, for the purpose of the retirement of the Capital Stock, to merge 
such surplus or deficit, and the amount of the stock to be canceled and 
retired, in a distinct account. This account may be given a suitable 
caption, as for example, Stockholders’ Distribution Account. 

The liabilities are liquidated, the accounts being debited to balance. 
The assets are realized and the respective accounts credited with the 
sums produced. Capital Stock Account is closed by a charge to balance. 
and a Stockholders’ Distribution Account is raised and credited with the 
amount. The debit and credit balances existing in the realized asset 
accounts, and any surplus or deficit, are carried to the Stockholders’ 
Distribution Account. Then, upon surrender of stock certificates for 
cancellation, each stockholder receives his pro rata share of the assets, 
whether cash, securities, or other assets, and the Stockholders’ Distribution 
Account is charged and the asset accounts credited. As the distribution 
progresses, the balance of the distribution account measures the assets 
undistributed. 

Thus, the balance sheet of a corporation about to be dissolved might 
be as follows: 


BLANK CORPORATION, BALANCE SHEET AS AT........ 


Assets Capital and Liabilities 
CM oe ak ee OSS OOO gs CADItAI LOCK: oe ane rates $100,000 
Seri. Par... 2... 5. 50,000 | Accounts. Payable....... 30,000 


[0s Oe 25,000 


$I 30,000 $1 30,000 


88 


It is assumed that the stock is held in equal amounts by A, B, C 
and D; that the liabilities are paid and the remaining assets distributed. 
The following entries would be necessary to close the books: 

ACCOUNTS (PAYABLE ta) sere eters ne vino $30,000 
To. CASH Utrera eer. pee $30,000 


CAPITAL SOC Kor tie, tit ia er nas eee Cees aes 100,000 
To STOCKHOLDERS’ DISTRIBUTION 
ACCOUNT atk ve et ot aha eee 100,000 


STOCKHOLDERS’ DISTRIBUTION AC- 
GW LOE Us Mase Bere peal FR Cad cages oy Spa 25,000 
boyd BN 0) 1 Ht barnes esd pede! aye ty peday - 25,000 


STOCKHOLDERS’ DISTRIBUTION AC- 
OUND ye cues sacra erates ee eee 75,000 
TO “CASH Are washer a Ree eee 25,000 
ee ia 0, Oi ds O) ie, GaN Reis wn lige h 50,000 


For assets turned over to stockholders for 
stock surrendered and canceled, being 75 
per cent upon its par value, as follows: 


Stock- | Par of PaIpD 
holder |. Stock. |>-————— 
Canceled} Cash Stock | Total 


| | | | 


Je $25,000] $6,250} $12,500) $18,750 
Bi. So a8 G00 6,250} 12,500] 18,750 
hua 25,000 6,250} 12,500] 18,750 
D 


Athi igieg 25,000 6,250} 12,500] 18,750 





$100,000] $25,000} $50,000] $75,000 








ADVANCED THEORY AND eke ies 


OF ACCOUNTS 
ORGANIZATION AND FINANCE 


- By HOMER ST. CLAIR PACE, C. P. A. (N. ¥.) 
“CORPORATIONS—LECTURE VIII 


LONG-TIME NOTES AND BONDS 


DePO ON RR i er fe rf ces Pes Ge phere ols hcejook a Tle elles 89 
POPE INOMES Oe ee ea OA oda ek ee ate 90 
Coupon-BEARER INCE HS anita yee ee koe Cay 93 
Pee) re A ee ae ur eet ahs 94 
We PON DONDS ih Wa pio ae ites ay ae 96 
PRESERVATION OF PAID UCOUPONS W060 wos Se 98 
UGISDERED BONDS. il i hy oe Re ee ily ae 99 
Bonps REGISTERED AS TO PRINCIPAL............-0.- 99 
~ Ciasses or Bonps....... Se a ee a 100 


CopyricutT, 1915, By 
HoMER ST. CLAIR PACE 


“PACE & PACE 


PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, 
AND ENGLISH, IN RESIDENCE AND BY EXTENSION 


a 30 CHURCH STREET, NEW YORK CITY 


Bey Gh 
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“Ww th 
ie: Sa St seep) Ng 
tbe Yay. es ne 


Dest oy 
Nak SOx Ae) ye 
gent St, GR ed 
& Pea ss ee fi 
AI Ne by 





ADVANCED THEORY AND PRACTICE OF 
ACCOUNTS 
ORGANIZATION AND FINANCE 


By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 
CORPORATIONS—LECTURE VIII 
LONG-TIME NOTES AND BONDS 


In General 

The capital of a corporation, at the outset, is derived from the pay- 
ment into the corporation of assets equal or greater in value to the par of 
the stock issued. This fund constitutes the accounting capital, that 
is, the excess of asset value possessed over the amount of liabilities owed. 
If profits are made and not withdrawn the accounting capital is increased 
by the amount thereof. 

In another sense, however, the capital is the aggregate wealth or 
property held and used by the enterprise, irrespective of the method 
by which it is added to the general fund. Thus, in case money or prop- 
erty is advanced to the corporation as a loan, instead of being contributed 
as a capital investment, its amount increases the fund of assets in hand 
and thereby the available asset capital. The accounting capital would 
not be increased by such a procedure, inasmuch as a liability is set up 
equal in amount to the asset value borrowed. 

The funds thus secured by loans may be divided, in a general way, 
between those obtained by long-time, or capital, loans, and those ob- 
tained by short-time, or current, loans. In the case of the former, it is 
quite usual to renew the loans upon maturity. When this is practicable 
and reasonably certain, and it is within the plans of the management 
of the corporation, the amount of such long-time, or capital, labilities, 
may be considered a permanent fund. Although it constitutes a liability, 
falling due to be paid at a certain time for a definite amount, and is not 
an element of proprietorship, the amount of such renewable capital liabilities 
may be added to the amount of issued capital stock to determine the amount 
of capital available for the permanent uses of the enterprise. 

Copyright, 1915, by Homer St. Clair Pace. 


90 


The assets secured by short-time loans are not acquired for per- 
manent use, but for current needs. Such loans rank as current liabili- 
ties and are payable out of current assets. 

Thus, it will be seen that corporate funds come, in the first place, 
through the proprietors, by the payment of stock or the accumulation of 
profits; and, in the second place, through advances by persons who thereby 
become creditors. The latter, for the repayment of their loans, have 
general and special rights in the assets of the corporation that are prior 
to those possessed by the proprietors. 

A current liability is most often an indebtedness for merchandise, 
material, labor, or money advanced, and stands as an open account or 
in the form of an unsecured promissory note. This form of liability re- 
quires no special consideration at this time. 

It is the purpose of this Lecture to consider the formal evidences 
of indebtedness issued on account of long-time advances or loans, usually 
classed as capital liabilities, and the procedures necessary to their proper 
treatment in accounts. 

Registered Notes 

There is no prescribed form of note or security necessary to be used 
in the borrowing of capital. The loan may be negotiated without the 
issuance of a note, or it may be upon the ordinary form of promissory 
note, or it may be upon a more formal, and secured, instrument. 

The procurement of loan capital in large amounts involves borrow- 
ings from a number of persons, or, to state it in more usual terms, it neces- 
sitates the sale of securities to such persons. Therefore, even though 
the object is effected through unsecured notes, it is usual to adopt a form 
of note that will be attractive to investors. 

For this purpose a registered note may be used. A clause is inserted 
in the face of the note providing for its registration, on the books of the 
company, in the name of the payee, and for the issuance of a new note 
to any designated transferee, upon the surrender of the old note with 
the power of attorney on the back thereof properly filled out. The notes 
are usually of some fixed denomination, say $500 or $1,000 each. For 
the purpose of identification, the notes may be issued in series, as Series 
A, Series B, etc., or they may be identified by a title including the year 
in which they mature, as 5% Registered Gold Notes of 1910, 5% Regis- 
tered Gold Notes of 1911, etc. 

The interest upon registered notes is paid, at the prescribed dates, 
to the holders of record, by check, or otherwise, as is convenient. 

In case of the loss or destruction of a registered note, the registered 
holder may obtain a new note upon proving his loss and filing a bond 


91 


of indemnity, usually for double the amount of the note, safeguarding 
the company against possible claims or loss. The registration in this 
way provides a satisfactory protection against loss. 

The notes should be printed with stubs, and bound in the same man- 
ner as a stock certificate book. The stub of each issued note is filled out 
with the name of the payee, date, and such other information as may 
be useful. A note ledger should be provided, and an account opened 
with each note-holder, showing address and the date and number of each 
note registered in his name. In case of transfers, the surrendered notes 
can be pasted back against their respective stubs, and the entry made 
direct therefrom to the note ledger. In case there are many transfers, 
the work may be facilitated by the use of a transfer journal. For interest- 
paying purposes, a list of the note-holders is prepared from the note ledger, 
and the total proved against the general ledger. The use of cards for the 
note ledger is often desirable on account of the convenience of the cards 
in addressing envelopes and preparing interest-paying lists. 

So far as the general books are concerned Cash, or other asset received, 
is charged and the note issue credited thus: 

LESSER ORE S010 OS ba ae $100,000 
TO 5% REGISTERED GOLD NOTES 
Gy EA oe ON CP ager ae a a ae $100,000 
For sale at par of notes Nos. 1 to 100 in- 
clusive, registered as follows: 


* * * ** * 


The general note account shows the total liability on account of 
the notes issued in this class, while the note ledger discloses the names 
and holdings of the individuals. 

The following is a form of a five-year registered note, the direct 
obligation of the company, without special security, as used in railway 
financing: 


3, $5,000. 
THE BLANK RAILWAY COMPANY 
FIVE PER CENT. FIVE-YEAR NOTE 
REGISTERED 
New York, N. Y., U. 5. A., August 1, 1904. 


On the first day of August, 1909, for value received, THz BLanKk 
RaILway Company (a corporation organized and existing under the laws 
of the State of Illinois) hereby promises to pay to 


ee eer a Ol 8, Oe Ole ele Oey ara 2 a Om a Vee abe Or) 6 6. 16) ely Oech se Lear 6 Fe OL RO Oey Om Oi eh ol BL eer efié e Gf fo te se 6 ee ee 8 em el Le 8 


92 


the sum of Five THousanp Do .tars ($5,000) in gold coin of the United 
States of America, of the present standard of weight and fineness, at its 
agency in the City of New York, and to pay interest thereon, at the rate 
of five per cent. per annum, in like gold coin, semi-annually on the first 
days of August and February in each year, from the .......... day of 


The registered holder of this note may, at his option, transfer the 
Same in person or by attorney duly authorized, upon the books of the 
Railway Company in the City of New York, or may exchange the same 
for a coupon note for the like principal sum with coupons attached matur- 
ing on and after the date when the next semi-annual instalment of interest 
would have been payable on such surrendered registered note. 

All payments on this note, either of principal or interest, shall be with- 
out deduction for any taxes which the said Railway Company may, be 
required to pay thereon or retain therefrom, under or by reason of any 
present or future law of the United States or of any State, County or 
Municipality therein. 

The Blank Railway Company reserves the right to redeem this Note 
on any interest day prior to maturity on 30 days’ notice at the rate of 
$101 per $100, and interest. 

THE BLANK RAILWAY COMPANY, 


ATTEST: Vice-President, 


Assistant Secretary 


Form of Stub: 


No. 
THE BLANK RaILway Co. 
$5,000 
5% 5-YEAR NOTE 
REGISTERED 





Issued to 


Date? of Issue voor. a4 ees cee ee 
Tnterest: frome ot ea ieee eae 


eo .)-@ ©. 2s) 0°" 2S be "Ee Ole ise 8) ee On Ore ee ee eee Pe 


93 


Form of Power of Attorney: 


Me MU Te BCRIVED S50... 200 1. fh ce deute hereby sell, assign and 
iene a ant he Ns £8 Sa) Se PAU sas the within 
Note of the Blank Railway RELY 3 and do hereby irrevocably constitute 
ne a sl eA a Re i i Vk bold Attorney 


to transfer said Note on the Books of the Railway Company in the City of 
New York, with full power of substitution in the premises. 


@ O. & 46 1a eo OL OC. © 6 oF 8) oO 6 O @ © Ce oe) OB Oy Oh ae 


The provisions of the last three paragraphs in the above form of 
note are no essential part of the form of registered note, but were inserted 
to meet the requirements of this particular note issue. | 


Coupon-Bearer Notes 


In the above form of registered note, provision is made for its con- 
version, at the option of the holder, into a coupon note. 

A coupon, or coupon-bearer, note, is one payable to bearer, and it 
therefore passes from hand to hand without the formality attaching to 
the transfer of registered notes. 

Instead of the interest being paid to registered holders at the regular 
interest period, coupons are attached to the note, one for each amount 
of interest falling due throughout the life of the note. In the coupon form 
of the registered note given, the interest is payable semi-annually, and 
each payment amounts to 23 per cent. upon $5,000, or $125. Therefore, 
if the note is dated August 1, 1904, Coupon No. 1 for $125 falls due on 
February 1, 1905, Coupon No. 2 for $125, being interest for the second 
six-months’ period, falls due August 1, 1905, and so on until the maturity 
of the note. This being a five-year note, there would be ten coupons 
attached. 

As the coupons mature they are detached, or clipped, as it is called, 
and are paid to bearer. It is customary to deposit coupons for collection 
by one’s bank in the same manner asacheck. The issuing company, upon 
payment of the coupon, cancels it. This canceled coupon should be filed 
as evidence of the payment of the interest. 


94 


The following is a form of the coupon: 

Coupon No. 1. 
$125.00. On February 1, 1905, Tot BLranxk RaILway 
ComPANY will pay the bearer at its agency in New York, 
One Hundred Twenty-five Dollars, in gold coin, being six 
months’ interest then due on its Five per cent. Five Year 
Note No. 1001. 

JoHN Dog, Treasurer. 


The form of the note is substantially the same as the registered note, 
except that it provides for payment to bearer, payment of interest by 
coupons, and conversion, at option of holder, into the registered form. 

In issuing a coupon-bearer note in exchange for a registered note, 
past due interest coupons are detached. 

No attempt is made to keep a record of the holders of the coupon- 
bearer notes by the issuing company. As conversions are often made 
from one form to the other, it is convenient to maintain an account in 
the note ledger for Coupon-Bearer Notes, treating the total of such notes 
as though held by one person. This brings all the notes issued into the one 
record, and its total can be proved against the general ledger account. 

The notes may be secured by the deposit of collateral with a trustee, 
in which case they may be known as Collateral Trust Notes. In fact, 
the provisions that may attach to such an issue are too numerous to 
specify, and little more than the general principles and procedures can 
be given. 


Bonds 


A bond is an obligation in writing and under seal. A fuller definition 
is that a bond is an instrument under seal whereby one acknowledges 
himself indebted to another in a specified sum, generally but not neces- 
sarily conditioned for the performance of some act. A single bond is 
one by which the obligor agrees to pay a certain sum of money to another 
at a determinable date. A conditional bond is one by which the obliga- 
tion becomes void upon the performance by the obligor of some act, other- 
Wise remaining in full force. 

It is not the present purpose to consider all classes of bonds and 
the legal principles and distinctions that are applicable thereto, but merely 
to discuss that type, classified as a single bond, by which the obligor pledges 
himself and, if a natural person, his heirs, executors and administrators, 
or, if a corporation, its successors, to pay to another a certain sum of money 
at a future determinable date. The bonds that represent, to a large extent, 
the capital liabilities of corporations, belong to this class. 


95 


The most important difference between the notes that have already 
been described, and the common form of bond, is that a lien attaches 
by mortgage to certain property as security for the payment of the prin- 
cipal and interest of the bond. The distinction between the bond and 
the mortgage securing its payment, is important, and to aid in making 
the distinction, the various forms of mortgage-secured debt will be con- 
sidered briefly. 

The simplest and most readily understood procedure for the secur- 
ing of debt by mortgage, and the one still in use in many of the states, 
is carried out by the borrower of money giving his promissory note there- 
for in the usual form. ‘To secure the payment of the note, when due, 
a mortgage, or conditional transfer of certain property, usually real estate, 
is made to the payee named in the note. In case the maker of the note 
fails to perform the conditions of the note, then the payee may, in accord- 
ance with the provisions of the mortgage and of the statutes in relation 
thereto, proceed to advertise and sell the property mortgaged for his 
benefit, and apply the proceeds thereof towards the payment of the amount 
of principal and interest, due him upon the note, and his proper costs. 

As a variation of this method of securing the payment of a loan, in 
New York and in other states, a bond and mortgage is given instead of 
a note secured by a mortgage. This type of bond is of the conditional 
class. The amount of the bond is usually for double the principal sum 
to be paid, the former being known as the penal sum. In case the obligor 
in the bond fails to meet his obligation, the property mortgaged as security 
to the bond can be sold, subject to the contract and statutory provisions, 
and the proceeds thereof applied to the payment of the principal sum, 
interest, costs, etc., the balance, if any, to be paid to the obligor. The 
penal amount of the bond is formal, and nothing beyond the actual amount 
due for the principal, interest and proper costs, can be collected. Originally 
the full amount of the bond could be collected, but the present rule is as 
stated. This is the procedure largely used in negotiating real estate loans. 

The methods of borrowing money upon note and mortgage, or bond 
and mortgage, that have been described, answer the purpose well enough 
in small undertakings and in many real estate transactions, but where 
large amounts of capital are to be raised upon a security of this kind, 
especially when the nature of the undertaking is for a long term of years 
or perpetual, as in the case of public service corporations, it is found to 
be much more economical and satisfactory to issue the obligation in some 
denomination convenient for transfer and trading, and secure the pay- 
ment of all of such obligations by the execution of one mortgage running 
to a trustee, whose right and duty it is to enforce the provisions of the 


96 


mortgage for the benefit of all of the holders of such bonds in case of a 
default in the payment of the agreed rate of interest or in the repayment 
of the principal. 

The ordinary type of corporate bond is issued under the provisions 
of such a trust deed or mortgage. The bond is a written undertaking, 
under seal, to pay to bearer, or to the order of another, a certain sum 
of money at some future determinable date. As in the case of the issue 
of notes, it is convenient to issue bonds of some fixed denomination, as 
for example, $1,000 each. Although for convenience in selling and trad- 
ing, the bonds are issued in certain denominations, in the general accounts 
of the corporation all of the bonds of a certain class are included and 
stated in one account. 

The amount of the outstanding bonds of an issue rank, under usual 
conditions, as a capital liability, the cash, or other property received, 
being set up as an asset. 

Authorized, but unissued, bonds are not carried into the accounts. 
If signed and sealed, although not actually delivered, they may be set 
up as Treasury Bonds, in order to charge the proper officer with their 
custody. 


Coupon Bonds 


The coupon, or coupon-bearer, form of mortgage bond is most 
acceptable to American investors. Like the coupon-bearer note, it passes 
from hand to hand without any formalities of transfer, and the interest 
is payable according to the tenor of interest coupons, alike payable to 
bearer, that are attached. A form of coupon-bearer bond issued by a 
railroad is as follows: 


No. 
UNITED STATES OF AMERICA 


STATE OF MINNESOTA 


THE BLANK RAILROAD COMPANY 
$1,000 | $1,000 
First Mortcace Gotp Bonp © 


The Blank Railroad Company, a corporation organized and existing 
under the laws of the State of Minnesota, promises to pay to the bearer 
One Thousand Dollars ($1,000), in gold coin of the United States of, or 
equal to, the present standard of weight and fineness, at its office in the 
City of New York on the first day of October, one thousand nine hundred 


97 


and fifty, and on presentation and surrender of the annexed coupons as 
they shall severally become due, to pay interest, in like gold coin, on 
such principal sum at the rate of four per cent. (4%) per annum from 
the first day of October, in the year one thousand nine hundred, until 
such principal sum shall be paid, such interest being payable on the first 
day of April and October in each year at its office or agency in the City 
of New York. 

This bond, with others of like tenor and date, is secured by a first 
mortgage bearing date the first day of October, A. D. 1900, to The Mer- 
cantile Trust Company, a corporation of the State of New York, as Trus- 
tee, conveying to said Trustee ninety-five and seventy one-hundredths 
(95.70) miles of completed railway, and a lease-hold estate in thirty-two 
miles of completed railway, against which the Railroad Company is au- 
thorized to issue, and the Trustee is directed to certify, Two Million 
Dollars ($2,000,000) of said bonds upon the execution and delivery of 
the mortgage. 
| The mortgage also provides that in case The Blank Railroad Com- 
pany shall hereafter buy additional rolling stock, or build or otherwise 
acquire an extension of said ninety-five and seventy one-hundredths 
(95.70) miles of railroad, or build or otherwise acquire branches, and shall 
convey said rolling stock or extensions or branches to the Trustee to be 
held subject to the terms of said mortgage, additional bonds may be 
issued in respect to said rolling stock to an amount not exceeding the 
actual cost, and in no event to exceed Two Thousand Dollars ($2,000) 
per mile of completed road then owned by the Railroad Company and 
in respect to extensions and branches at the rate of Twenty Thousand 
Dollars ($20,000) per mile, and for the purpose of procuring additional 
ground and terminal facilities in the cities of Red Wing and Mankato, 
an additional amount not exceeding the actual expenditures and not 
exceeding One Hundred and Fifty Thousand Dollars ($150,000). 

If default shall be made in the payment of interest which shall accrue 
upon any of the bonds secured by said mortgage, the principal thereof 
may be made due and payable as provided in said mortgage. 

This bond shall not be valid until the certificate endorsed hereon shall 
have been duly executed by the Trustee. 


IN WITNESS WHEREOF, The said Blank Railroad Company has 
caused the signatures of its President and Secretary to be affixed hereto 
this first day of October A. D. 1900. 


98 


The mortgage or deed of trust securing this bond has been duly 


stamped according to law. 
THE BLANK RAILROAD COMPANY, 
by 
Attest: 


e.0 @ ¢ © @ @ « © 66 @ ¢ © 8° 2 Oe is) Bewe ene eee 


ESTER CRUDE ERS ZIRE HO PSUe Sen ede President. 
secretary. 
Attached to the foregoing bond were 100 interest coupons, cover- 
ing the semi-annual interest payments for the fifty years of the life of 
the bond. The following is the form of the coupon: 


The Blank Railroad Company will on the first day | Coupon 
of April, A. D. 1901, pay to the Bearer at its officein the | No. 1 
City of New York, Twenty Dollars ($20) in gold coin of 
the United States, being six months’ interest then due 
on its First Mortgage Gold Bond No..... $20 


The coupon usually bears the engraved signature of the Treasurer, 

As is usual in such cases, the bond does not come under the pro- 
tection of the trust deed or mortgage unless it is authenticated by the 
trustee. For this purpose a trustee’s certificate is provided, to be signed 
by the trustee, the form, in this case, being as follows: 


TRUSTEE’S CERTIFICATE 


The Mercantile Trust Company, a corporation of the State 
of New York, hereby certifies that this is one of the Bonds de- 
scribed in a certain mortgage or deed of trust, executed by The 
Blank Railroad Company to the undersigned as Trustee, bearing 
date the first day of October, 1900. 

THE MERCANTILE TRuST Company, Trustee, 
by 


Vice-President. 


Preservation of Paid Coupons 


The paid coupons should be canceled as paid, and preserved in order 
that they may be presented to the Trustee, with the paid bonds, at the 
time of the retirement of the bonds. In case of the loss or destruction 
of any such bonds or coupons, the Trustee will require a bond, indem- 
nifying it against loss through possible claims upon it for payment, usually 
for double the amount of the par of such bonds and coupons, before it 


99 


will execute a release of the trust deed or mortgage. This matter may 
be raised long before the maturity of the bond through consolidations or 
reorganizations that render the retirement of the issue desirable. 

For the purpose of preserving such paid and canceled coupons, in 
case the issue is large, a book may be provided for each maturing coupon, 
in which spaces are given numbers to correspond with the numbers of 
the bonds. Thus, upon the maturity of the first coupon a book marked 
Coupon No. 1 would be provided, with a space for coupon from bond 
1, bond 2, bond 3, etc., the number being printed in the space, and each 
coupon as paid and canceled would be pasted in its respective place. Upon 
the maturity of the second coupon a book for Coupon No. 2 would be 
provided, and so on. An inspection of the books would readily disclose 
the bonds for which coupons had not been paid. 

In some cases the paid coupons are burned in the presence of repre- 
sentatives of the interested parties and an affidavit, known as a cremation 
certificate, is made of the fact, and this certificate is accepted by the 
ELUSTEE. 

Registered Bonds 

A purchaser of a negotiable instrument, in good faith, for value, 
acquires title thereto, although the vendor may have acquired the instru- 
ment by fraud and possessed no title. This has been held to apply to 
bonds, and there is thus constituted a danger in case the bonds fall into 
dishonest hands. 

To overcome this, it may be provided that the coupon-bearer bonds 
can be converted into registered bonds. The conditions are similar to 
those stated in the case of registered notes, and the accounting records 
necessary are substantially the same. ‘The interest is paid to the regis- 
tered holder, usually by check. It is not considered necessary to include 
a form of registered bond. 


Bonds Registered as to Principal 

In lieu of a clause in the trust deed for full registry, provision may 
be made for the registry of the principal of the coupon-bearer bond. For 
this purpose, space is provided on the reverse of the bond in which the 
name of the owner may be recorded by the company, or its transfer agent, 
the ownership being recorded in the books of the company. ‘Thereafter 
no new owner will be recognized except upon formal transfer by the 
registered owner. The bond may be assigned in blank, thereby reverting 
to its bearer form, or it may be assigned or transferred to another registered 
holder, whose name, in turn is entered on the bond and in the books of 
the company. 


100 


The interest is payable by bearer coupon and is not registered. The 
chance of loss, however, is reduced by this method to small proportions. 


Classes of Bonds 


Bonds have been classified, so far as their form is concerned, into 
coupon-bearer, registered, and registered as to principal. 

Aside from the foregoing, they may be classified as to their nature, 
and bonds thus classified may take any one of the three forms stated. 
Thus, a first mortgage bond is one that is secured by a first lien on a 
particular property, although it may be in coupon-bearer, registered, 
or registered-as-to-principal form. 

A second mortgage bond is one secured by a mortgage subject to a 
prior first lien, and, similarly, there may be a third mortgage bond, subject 
to two prior liens, although this is not so common. 

A collateral trust bond is one secured, under the terms of a trust 
deed or contract, by the deposit of collateral securities. These may 
be mortgage bonds of other companies, which, in some cases, provide an 
interest return more than sufficient to pay the interest on the bonds secured. 
In such a case the surplus may be used to create a sinking fund to apply 
towards the payment of the bonds secured. 

A consolidated bond is usually one secured by a mortgage on a prop- 
erty formed by the consolidation of several properties, and may be subject 
to prior liens on the various properties. In contradistinction, a divisional 
bond is one secured on a part of the property, as a branch railroad line. 

A convertible bond is one that may be converted into some other 
security, usually capital stock, upon certain contingencies. Such a bond, 
from its convertibility, has more speculative possibilities, as a rule, than 
other forms of bonds. 

An income bond is one providing for the payment of interest out 
of income, if earned. Thus, an income bond issued in 1903 provided 
that the payment of interest for the seven years ending 1910 should depend 
upon the earnings, and after 1910 the interest charge became absolute. 

A debenture has been defined to be ‘“‘an instrument in writing, 
generally under seal, creating a definite charge on a definite or indefinite 
fund or subject of property, payable to a given person, etc., and usually 
constituting one of a series of similar instruments.’’ The term is applied 
to both stocks and bonds. 

There are many titles given to bonds, words being chosen to convey 
briefly the essential characteristic of the security. The most common 
have been described. 








ay 


ORGANIZATION ‘AND FINANCE. 
CORPORATIONS. 
By HOMER ST. CLAIR PACE, GC. P’ A, 
LECTURE IX. 


_ LONG-TIME NOTES AND BONDS--.Continued. 


STATUTORY PROVISIONS...... 


(BONDS SOLD at a Discount ey... 20... 
> Save oF Bonps aT A PREMIUM. .<-... 0.2... 


PS Scithi ROR GROPERTY cca eh ay och ae eeu ee 
SALE OF STOCK AT A PREMIUM..... ee ae POUR a a ae i) 
PURCHASE AND. SALE OF BONDs.... 


Pe MIM ON-DONDG PURCHASED is Ue SS uae ita 
~- Discount oN Bonps PuRcCHASED. . : 


' PaYMENT OF COUPONS........ 


MURPLUS CREATED BY REDUCTION OF STOCK. 200 Peis.) ooo 
P CONSALIDATED, BALANCE SHEET 220. 0540 os Se seria 
CoNDENSED GENERAL BALANCE SHEET OF UNITED STaTESs STEEL 


PAPO ORATION foe ia ie Cale eile een Gl whew a's SO ASV asstek Wont seep 


COPYRIGHT, I912, BY 
Homer St. CLair Pace: 


_ ADVANCED THEORY OF ACCOUNTS. 


IOo.t 


102 


103 
104 
104 
105 
106. 
106 
107 
108 


store) 





ADVANCED THEORY OF ACCOUNTS. 
ORGANIZATION AND FINANCE. 


CORPORATIONS. 
PreconL hoo bo CLAIR PACK, CPA. 
LECTURE IX. 


LONG-TIME NOTES AND BONDS—Continued. 


Statutory Provisions. 


It is provided by the New York Stock Corporations Law that, in 
addition to the powers conferred by the General Corporation Law, every 
stock corporation shall have the power to borrow money and contract 
debts when necessary for the transaction of its business or for the exercise 
of its corporate rights, privileges or franchises, or for any other lawful 
purpose of its incorporation; and it may issue and dispose of its obliga- 
tions for any amount so borrowed, and may mortgage its property and 
franchises to secure the payment of such obligations, or of any debt con- 
tracted for said purposes. Every such mortgage, except purchase-money 
mortgages, and mortgages authorized by contracts made prior to May 
1, 1891, shall be consented to by the holders of not less than two-thirds 
of the capital stock of the corporation, which consent shall be given 
either in writing or by vote at a special meeting of stockholders called 
for that purpose. 

When authorized by like consent, the directors may confer upon 
the holder of any debt or obligation, whether secured or unsecured, 
evidenced by bonds of the corporation, the right to convert the principal 
thereof, after two and not more than twelve years after the date of such 
bonds, into stock of the corporation. 

There is a special provision in the Railway Law applicable to the 
issue of bonds by railroad companies, which it is not necessary to con- 
sider at this time. 

The provision of the New York Law that no corporation shall issue 
stock or bonds except for money, labor done or property actually received 


Copyright, 1912, by Homer St. Clair Pace. 


102 


for the use and lawful purposes of the corporation, states that property 
purchased may be paid for in stock to the amount of the value thereof, 
but it does not provide that the money, labor done or property received 
for bonds shall equal in value the par value of such bonds. Thus, while 
stock may not be issued for less than the par value, there is apparently 
no such limitation in the statute upon the issue of bonds. 

Under the New York law, the owner or holder of any corporate or 
municipal bond or obligation (except such as are designated to circulate 
as money, payable to bearer), heretofore and hereafter issued in, and 
payable in, New York, but not registered in pursuance of any State law, 
may make such bond or obligation, or the interest coupon appending to 
the same, non-negotiable by subscribing his name to a statement endorsed 
thereon that such bond or obligation or coupon, is his property, and there- 
after the principal sum therein mentioned is payable only to such owner 
or holder, or his legal representatives or assigns, unless such bond, obliga- 
tion or coupon be transferred by endorsement in blank, or payable to 
bearer, or to order, with the addition of the assignor’s place of residence. 


Bonds Sold at a Discount. 


In case a bond is sold at exactly the amount of its par, an asset is 
received equal in amount to the liability set up, and the interest that 
is properly a charge on account thereof is the rate named in the obliga- 
tion itself. 

It is not unusual, however, for bonds to be sold at a discount, or 
premium, depending upon the security of the obligation and the pre- 
vailing rates of interest in the money market. Thus, a bond that bears 
a nominal interest rate of 4 per cent. say, in case the ruling rate for money 
loaned on obligations of equal security is 5 per cent., would not sell except 
at a discount, say, to illustrate, at 90. The 10 per cent. discount is the 
penalty exacted because the nominal rate named in the bond is not suf- 
ficient to give the current return upon the investment. It is an addition 
to the nominal interest rate, which, instead of being paid in money from 
time to time as the interest periods mature, is settled with the 
holder of the security in the first instance by the purchaser’s receiving 
a bond, part of which is issued to make good an insufficient nominal 
interest consideration. 

In the case of the sale of one hundred bonds of the par value of $1,000 
each, amounting to $100,000, bearing interest at 4 per cent., at a price 
of 90, Cash would be charged with the proceeds, $90,000, Discount on 
Bonds with the amount of discount, $10,000, and Mortgage Bonds would 
be credited with the total, $100,000, the latter to record the liability. 


103 


The practice of capitalizing, or carrying to the cost of property, such 
discount on bonds is not infrequently met in practice, and is theoretically 
incorrect because it does not represent asset value, but an amount that 
should be a charge against profits on account of interest, distributed 
over the life of the bond. 

It being assumed that the term of the $100,000 of bonds is ten years, 
and the questions of compound interest necessary to determine the exact 
amount chargeable against profits each year being disregarded, it may be 
approximated that, inasmuch as the bonds are for ten years one- 
tenth of the discount should be charged against profits each year in 
addition to the nominal interest charge, giving a net charge on account 
of interest of five per cent. a year. This procedure would be carried 
out by setting up, in the first instance, the entire amount of the dis- 
count, and holding it upon the books as a deferred charge, debiting, at 
the time of closing the books each year, the proportionate amount for 
that year, against Profit & Loss. The nominal interest, being the amount 
actually paid in cash, is also charged to Profit & Loss, the latter thus 
receiving as a debit the full amount chargeable on account of interest. 
The Discount Account, standing as a deferred charge, will be reduced 
year by year by the credits until, at the time of the maturity of the bonds, 
it will have disappeared from the books, 

It is interesting to trace this procedure a step further, in order to 
fix the principle clearly in mind. It will be recalled that, in the first 
place, a liability of $100,000 was set up, for which assets, amounting 
to only $90,000, were received. It is necessary to accumulate in the 
business during the life of the bond, an additional $10,000 of assets, so 
that there may be available, in conjunction with the $90,000 of assets, 
an amount sufficient to equal the amount of the maturing bonds. The 
accounting procedure that has been outlined merely provides for this by 
withholding from profit during the life of the bond $10,000, representing 
asset value to that amount on the debit side of the accounts. It is not 
intended to convey the impression that the assets thus accumulated are 
specifically ear-marked, or accumulated in a sinking fund, but merely 
that general asset value is withheld from profit distribution in order to 
keep the accounts in accordance with sound accounting principles, 


Sale of Bonds at a Premium. 


The condition may be found of a sale of bonds at a premium, that is, 
at a price in excess of the par value, and such excess should be credited 
to a distinct account that may be called Premium on Bonds Sold Account 
or Bond Premium Account. The incorrect practice of treating such a 


104 


premium as a profit or surplus is sometimes carried out. However, the 
principles governing the sale of bonds at a discount apply here, except 
that the opposite condition is found. The nominal interest rate specified 
in the bond itself is so high, in conjunction with the security afforded, 
that the bonds sell for a price in excess of par, and the premium so received 
is an amount paid in advance by the purchaser for the privilege of collecting 
the nominal rate specified in the bonds during successive interest periods. 
So far as the corporation is concerned, it is an amount received against 
an amount later to be paid as interest, and should be used as a reduc- 
tion of the nominal interest charge. 

Thus, if an issue of bonds is sold at 110, say, $100,000 of bonds at 
$110,000, bearing six per cent. interest, maturing in twenty years, the 
annual interest charge thereon would be $6,000. Disregarding questions 
of compound interest, at the end of the first year, assuming that the 
interest were paid annually, a proportionate amount of the premium 
should be transferred from the Premium Account to Profit & Loss, say 
one-twentieth, or $500. The nominal interest, $6,000, is then charged 
against Profit & Loss, and the correct net effect of a charge of $5,500, 
on account of interest is secured. The Premium Account will then stand 
credited with $9,500, being the amount applicable to the reduction of 
the nominal interest during the remaining nineteen years of the life of 
the bond. The same result may be achieved by other methods, but the 
principle is as stated. 

If, instead of this procedure, the Premium Account were held at its 
full amount, and the nominal interest were charged against each Profit & 
Loss period, the amount of such Premium Account would be a true surplus 
at the time of the maturity of the bond, growing out of the fact that 
Profit & Loss had been overcharged during each Profit & Loss period by 
the failure to take into account the proportionate amount of the premium. 


Bonds Issued for Property. 


In case of the receipt of property for an issue of bonds, instead of the 
receipt of money, the same principles apply in case the value of the prop- 
erty, determined in the best manner possible, varies from the par of the 
bonds. The appraisement of the property is a matter to be considered 
upon the merits of each individual case, although ordinarily the asset. 
would be set up at the amount of the liability incurred on account thereof. 


Sale of Stock at a Premium. 


The sale of stock at an amount above its par is not uncommon, and 
the amount of such excess constitutes a surplus that, in ordinary con- 


105 


servative practice, is held for the uses of the corporation. Such a surplus, 
however, may be distributed as profit. 

The surplus created by the issue of stock at a premium should not 
be confused with the premium received on account of an issue of bonds, 
for the reason that stock is not a liability, and does not come due at any 
time nor in any amount. The return‘upon stock is in the nature of a 
dividend, or a sharing of profits, and is not interest that can be accrued 
from day to day. Therefore, the whole theory of payment for the use 
of money involved in an issue of bonds bearing interest does not apply 
to stock. 

The amount of the premium received on an issue of stock should not 
be confused with the profit derived from trading or operation, but should 
be carried into Profit & Loss or Income in a division created for such 
extraordinary items. 


Purchase and Sale of Bonds. 


It is now the rule upon the New York Stock Exchange to quote the 
prices on bonds without interest, the amount of the accrued interest 
being added to the price of the bond. Thus if a bond is sold at go, the 
price is calculated as go per cent. of the par, less the broker’s commission, 
and plus the amount of interest that has accrued to the date of delivery. 
In the case of the sale at go of a four per cent. bond of the par value of 
$1,000, interest payable on the first days of October and April in each year, 
sold for delivery on November 13, the price will be calculated as 90 per 
cent. of $1,000, or $900, less the broker’s commission of one-eighth of one 
per cent. of the par value of the bond, $1.25, and plus interest at four per 
cent on the par value of the bond, for one month and twelve days, $4.66, 
amounting to $903.41. 

A security, whether a bond or otherwise, is recorded in the accounts 
at its cost, irrespective of its par value. Thus, in the illustration given 
the purchaser will add to the price of 90 the commission, giving the pur- 
chase price of the bond proper as $901.25. The accrued interest may 
be best charged to an Accrued Interest Account, which will be credited 
to balance the charge upon the collection of the interest. 

The commission of a stock broker is always calculated upon the par 
of the security, whether a stock or bond, and is figured at one-eighth of 
one per cent. It is deducted from the proceeds of securities sold, and is 
added to the cost of securities purchased, making the net price one-eighth 
of one per cent. less or more than the quoted price, as the case may be. 

It is often found useful, notwithstanding the fact that securities 
are recorded at cost instead of par, to record the par of the security in 


106 


the explanation column on the debit side of the ledger as purchases are 
made, and to record the par of the security in the explanation column 
on the credit side of the ledger as sales are made, so that, by obtaining 
the difference between the par, recorded in such explanatory columns, 
the par value of the securities on hand may be determined. This does 
not affect in any way the regular money columns. The procedure is 
useful in determining the par value of any security on hand and in check- 
ing against securities held in a vault. The shares may be used instead 
of par value in the case of stocks. 


Premium on Bonds Purchased. 


In the case of the purchase of bonds tor investment purposes at a 
premium, that is, at a price in excess of the par value, such premium 
is an amount paid for the privilege of collecting the nominal interest 
rate specified in the bond, and in order to determine the net interest 
return, it is necessary to charge against the nominal return for each 
interest period a proportionate amount of the premium thus paid. Thus, 
in the case of the purchase of a bond of $1,000 par value, maturing in 
ten years, at a premium of to per cent., bearing a nominal interest rate 
of 4 per cent. per annum, the bond will fall due to be paid upon maturity, 
not at the cost thereof, $1,100, but at the par value thereof, $1,000. There- 
fore, the amount of this premium must be withheld from the nominal 
interest collected, in order not to overstate net profits or income. 

In order to record the purchase of the bond, the entire amount, ex- 
cluding the accrued interest at the time of the purchase, but including 
the excess amount paid over the par value of the bond, may be charged 
to a bond account under a suitable caption. At the time of the receipt 
of the nominal interest, Cash is charged and Interest is credited for the 
full amount thereof less the proportionate amount necessary to reduce 
the premium. This proportionate amount is credited to the bond account. 
This procedure being carried out for each interest period, the bond account, 
during the life of the bond, will be written down to its par value. There 
are several accounting procedures by which this result may be accom- 
plished, but the one given illustrates fully the principles. 


Discount on Bonds Purchased. 


In case of the purchase of a bond at less than par, inasmuch as an 
obligation is held that will mature and be collectible at an amount in 
excess of its cost, in theory the amount of such excess is an addition to 
the nominal interest received. The omission of such increment results 
in nothing more than the omission of an unrealized profit. 


107 


Payment of Coupons. 


The payment of coupons is usually made by establishing, with a 
bank or other financial institution, a fund equal to the amount of the 
maturing coupons. This is set aside by the bank from other accounts 
and funds and is held especially for the purpose of paying the coupons 
as they are presented. Through the absence of holders of bonds, or through 
the loss or destruction of bonds or coupons, it often happens that there 
is a balance left with the bank or other agent on account of coupons, 
payment for which has not been demanded. The amount thus left belongs, 
in the absence of claimants, to the corporation, and it is therefore desir- 
able to have a record of the amount on the books of the corporation. 
Were the corporation, in its accounts, to charge off to Interest Account 
the full amount of the coupons, no record would exist. The better practice 
is to charge Interest and credit Coupons Payable, for the full amount 
of the maturing coupon. At the end of each month, a statement of cou- 
pons paid is received from the bank, or other disbursing agent, and the 
amount thereof is charged to Coupons Payable, and the special fund, 
which before has been set up as a charge to the bank, is credited. There 
will thus exist at the end of each month, after the accounts are written 
up, a net charge to the bank or other agent for the amount of funds not 
disbursed, and on the other side of the accounts a balance to Coupons 
Payable, measuring the liability for coupons due, but not presented. 

There usually is a provision in a mortgage to the effect that the cor- 
poration or its agent shall pay the coupons as they mature, and the selec- 
tion of such an agent is a matter entirely within the power of the corpora- 
tion. Therefore, any balance of funds on hand with an agent is merely 
held for the purpose of meeting the payment of the coupons whenever 
presented. In the absence of presentation of coupons the fund would 
belong to the corporation, and it is desirable and necessary not to eliminate 
the amount thereof from the corporate records. 

In case a bank or trust company is allowing interest upon cash bal- 
ances, the interest upon funds set aside for the purpose of paying coupons 
ceases from the time of such transfer from the general fund. While a 
large percentage of coupons would be presented on the date of maturity, 
there are many that do not come in for weeks and months, and in some 
cases even years, after the due date. Bankers not infrequently do not 
make a special charge for the payment of coupons, especially when the 
amounts are large, receiving their compensation therefor by thus setting 
aside the fund and receiving the benefit of the use of the portions not 
immediately called for payment. 


108 


Surplus Created by Reduction of Stock. 


The distinction between operating surplus, available for dividend 
purposes, and surplus created by the reduction of capital, may become 
important when the question of dividends upon preferred stock arises. 
In the case of Roberts vs. Roberts-Wicks Company, 184 New York 257, 
this question was discussed at length and decided, as will appear from 
the following extracts: 


‘The capital had become impaired to the extent of upwards 
of $90,000 and no dividends had been declared to its stock- 
holders. 

“In the charter and in the certificates issued to the pre- 
ferred stockholders, it was stated what was to be the nature of 
the preference which was accorded to that class (preferred) of 
stockholders; namely, to be paid ‘out of the surplus profits 
arising from the business of the corporation’ a dividend equal 
to 6 per cent. per annum on the preferred stock before any divi- 
dend shall be paid on the common stock; such dividend on the 
preferred stock shall be cumulative. 

“Each class of stock was part of the whole capital stock 
and both classes were made by the charter alike in all respects, 
except in the one respect that the preferred stock was entitled 
to have ‘the surplus profits arising from the business’ appro- 
priated, in first order, to the payment of 6 per cent. dividends, 
cumulatively. 

“When * * * directors met to act upon the question of 
dividends, their duty was, in dividing the surplus profits, to 
apply them, in first order, to the satisfaction of the debt to the 
preferred stockholders for arrears of dividends. 

“For the purpose of such a dividend, however, only such 
surplus as represented the profits from the business could, legally, 
be availed of, and this brings us to consider the question of the 
disposition of the surplus of capital, left upon the reduction of 
capital stock, which the appellant claims to be equivalent to sur- 
plus profits and, hence, to be applicable upon the company’s debt 
to the preferred stockholders on account of arrears of dividends. 
* * * As stated, the capital had become impaired to the extent 
of $90,861.85, and this necessitated the reduction as then effected. 
The reduction to $200,000 thus left $9,138.15, which was an 
excess, or surplus, of capital. We may assume that the directors 
could have converted it into cash and have distributed it by way 
of dividends; but the preferential right of the preferred stock- 
holders did not reach to a distribution of that which was capital, 
nor create any charge upon capital. That which constitutes the 
capital stock of a corporation belongs to all of its stockholders, 
proportionately to their holdings. Upon dissolution, or in 
liquidation, it entitles him to share ratably in the assets. If the 


109 


directors had undertaken to divide this surplus of capital, it was 
apportionable, only, among all the stockholders ratably. The 
statute contemplated nothing else than that. 

“The statute reads: ‘If the capital stock is reduced, the 
amount of capital over and above the amount of reduced capital 
shall, if the meeting so determine, be returned to the stock- 
holders pro rata. ; 

‘“ Assuming that the directors were empowered to distribute 
this surplus of capital, the preferred stockholders would have 
no legal, or equitable, claim upon it in satisfaction of past due 
dividends. Their only right would be to share in such a dis- 
tribution ratably with the common stockholders. 

“It must be borne in mind that the $9,138.15 remained in 
the corporate accounts, after the reduction of capital stock, 
as a portion of the former capital, and was, in no sense, like an 
excess of property which had been accumulated in the conduct 
of the business beyond the fixed capital. It did not represent 
‘surplus profits arising from the business.’ 

‘“T have, therefore, reached the conclusion as to this sur- 
plus of capital, left on hand after the reduction of the capital 
stock from $300,000 to $200,000, that it was not applicable to 
the claim of the preferred stockholders for the arrears of unpaid 
dividends.”’ 


Consolidated Balance Sheet. 


Corporations in many cases are authorized to acquire and hold the 
capital stock of other corporations. In practice, the holdings may vary 
from a few shares purchased for investment, or speculation, to a con- 
dition where practically all of the stock of another corporation is held. 
In fact, the corporation may be a holding corporation, organized merely 
to hold the stock of other corporations, all of the actual activities being 
carried on by the corporations whose stock is held and controlled. 

In the case of the control of a corporation resting in another corpo- 
ration, the controlled corporation is known as a subsidiary corporation and 
the corporation owning the stock is known as a holding, or parent, cor- 
poration, although the term holding is applied most often to corporations 
that do not themselves conduct activities but merely hold the stocks of 
operating companies. Aside from the legal complications that arise in 
such circumstances, there are many important matters to be considered 
from an accounting point of view. 

The balance sheet of each corporation will, if properly prepared, 
disclose its financial position, but it is difficult to obtain, from a study 
of the separate statements of parent and subsidiary corporations an idea 
of the condition of the enterprise as a whole. This is desirable, in view 


IIo 


of the fact that, so far as actual ownership is concerned, the activities 
practically constitute a single enterprise. 

In order that the situation may be readily grasped an illustration 
will be given. Corporation A is capitalized at $1,000,000 and has a 
surplus, that is, an excess of asset value over the combined amount of 
liabilities and capital stock, of $200,000. It owns 90 per cent. of the 
stock of Corporation B, capitalized at $100,000, which it acquired 
and charged in its accounts at par. Corporation A also owns all of the 
stock of Corporation C, capitalized at $50,000, which it acquired and 
charged at 95 cents on the dollar. The balance sheets of the respective 
corporations may be stated, for the purpose of illustration, as under: 


BALANCE SHEET OF CORPORATION A 
DECEMBER 31, 1902 








Assets Liabilities 
Capital Assets $950,000 || Capital Stock. ...... $1,000,000 
Stock of subsidiary cor- Capital Liabilities.... 100,000 
porations: Current Liabilities... 35,000 
Corporation B at par Q0;000 "| "pirpitis. oer 200,000 
Corporation C at 95.. 47,500 
Current Assets........ 247,500 


$1,335,000 $1,335,000 





BALANCE SHEET OF CORPORATION B 


DECEMBER 31, 1902 






Assets Liabilities 
Capital Assets $230,000 || Capital Stock....... $100,000 
Current Assets......... 70,000 || Current Liabilities. .. 125,000 





2 Sn heiee 75,000 


$300,000 


LAG 


BALANCE SHEET OF CORPORATION C 


DECEMBER 31, 1902 


Assets Liabilities 
eital Assets... . 6.2. $50,000 || Capital Stock....... $50,000 
Surrent Assets.....5... 95,000 || Capital Liabilities... 40,000 
(OULU aa a 25,000 || Current Liabilities... 80,000 
$170,000 $170,000 


The book value of the stock of a corporation is the amount by which 
the assets, correctly valued, exceed the liabilities. Stated in another 
way, it is the amount of capital stock plus the surplus or less the deficit. 
Thus, the book value of the Capital Stock of Corporation B above is 
$175,000, or $175 to each $100 of stock. The book value in such a case 
would be stated as 175. 

Inasmuch as the stocks of Corporations B and C are carried in the 
Balance Sheet of Corporation A, at cost, the full effect of the values that 
exist in the subsidiary corporations is not disclosed. This effect may 
be shown by adjusting the value of the subsidiary stocks as carried in 
A’s books to book value. In the case of the stock of B 75 per cent. would 
have to be added to the $90,000, or $67,500, making the total value 
$157,500, and the $67,500 would be credited to surplus. In the case 
of the stock of C, the book value is only 50, or $25,000, so the shrink, 
$22,500, must be charged to Surplus and credited to Stock of Corporation 
C. Surplus, after these adjustments, would stand with a credit balance 
of $245,000. 

This expedient, while disclosing in the Balance Sheet of Corporation 
A the net condition in accordance with the best values obtainable, would 
not disclose the full facts as to the assets and liabilities of the respective 
subsidiary corporations, and it would be clumsy to carry through such 
adjustments as the book values of the stocks of the subsidiary corpora- 
tions fluctuated. 

Instead of the foregoing, a better accounting procedure is to prepare 
a statement known as a Consolidated Balance Sheet, in which all of the 
assets and outstanding liabilities, and the stock issued and in the hands 
of outside parties, are shown. This is prepared without the necessity 
for adjustment entries, by a consolidation of the items in the various 
financial statements. It is obvious that the use of the actual assets and 
liabilities in such a statement, with the elimination of the stock owner- 


II2 


ship, will give the same net effect upon Surplus as the use of the net in- 
creases and decreases of book value. 

Thus, the Capital assets would be shown in the consolidated state- 
ment as $1,230,000, made up as follows: 


A odin bose Wate 6) Riou whe nla OU aU epee ang NOt re ain 
Boy 5 olen kchiantits eS AE ae a ee ce 230,000 
OM ea errs ce ee ee 50,000 

$1,230,000 


In the same manner other items would be consolidated, but the 
ownership of the subsidiary companies’ stock appearing in the parent 
corporation as a debit balance, and its issue appearing in the subsidiary 
corporations as credit balances, would be eliminated. 

The Consolidated Balance Sheet when thus prepared would appear 
as follows: 


CONSOLIDATED BALANCE SHEET OF CORPORATIONS A, 
B AND C AS AT DECEMBER 31, 1902 





Assets Laabilities 

Capital Assets.ioees oer $1,230,000 || Capital Stock A....... $1,000,000 
Current Assets.......... 412,500 || Capital Stock B $10,000 
Surplus...... 7,500 

17,500 

Capital Liabilities..... 140,000 

Current Liabilities... .. 240,000 

Slirplig. SY Sere 245,000 

$1,642,500 | $1,642,500 


The same surplus, $245,000, is achieved as in the case of the adjust- 
ment entries. Instead, however, of the net asset value of A’s holdings in 
each subsidiary corporation being shown, the entire assets and the entire 
liabilities are shown, presenting a much fuller financial statement. 

In case a portion of the stock of a subsidiary corporation is held by 
outside interests, the theoretical treatment is to apportion to it its share 
of the surplus or deficit, and show the net effect in the Consolidated 
Balance Sheet. In the case of the $10,000 of B stock outstanding, the 
surplus applicable thereto on the basis of values shown, $7,500, is added 
to the amount of the stock, to show the estimated interest of the holders 


Dist 


of such stock in case of a realization and liquidation on the basis shown. 
In practice, when the outstanding stock is small in amount, it is often 
carried into the statement at par. 

The liabilities rank against the assets of the corporation for which 
they are incurred, and not against the assets as a whole. This however, 
does not affect the showing of the financial condition of the entire enter- 
prise, and reference may be had to the subsidiary balance sheets, which 
should always support the consolidated statement, for information as 
to the liabilities of the respective corporations. 

The Consolidated Balance Sheet is one of the accounting devices 
that has come with the tendency to consolidate corporate interests. It 
is principally useful where practically the entire ownership of subsidiary 
concerns rests in a holding corporation. 


Condensed General Balance Sheet of United States Steel 
Corporation. 


For the purpose of illustrating the principles of the consolidated 
balance sheet, the financial statement of the United States Steel Corpora- 
tion as at December 31, 1906, as published, is presented herewith asa 
complicated example, and it is believed that a careful study thereof will 
well repay the student. 

It will be noted, in the first place, that the term Condensed General 
Balance Sheet is used instead of Consolidated Balance Sheet, although it 
embraces the assets and liabilities of subsidiary corporations as well as 
of the parent corporation. Either designation will answer, although some 
confusion might result from the fact that the term Condensed Balance 
Sheet is often used, especially in railway practice, to describe a balance 
sheet that does not include the assets and liabilities of subsidiary corpo- 
rations, but is merely a condensation of the ordinary balance sheet of 
the parent company. In the statement under review the idea of the con- 
solidation may be gathered from the word General, which is used with the 
word Condensed. 

Under the caption Liabilities are included the stocks of subsidiary 
companies not held by the United States Steel Corporation, which are 
stated at par value. It has already been pointed out that when the 
amounts of stock thus outstanding. are inconsiderable, they are usually 
taken into the statement at par. 

Incidentally, the treatment of deferred charges to operations, sink- 
ing and reserve funds, and surplus, will be of interest to the student. 


114 


CONDENSED GENERAL BALANCE 


ASSETS. 
PROPERTY ACCOUNT: 

PROPERTIES OWNED AND OPERATED BY THE SEVERAL COMPANIES: 
Balance of this account as of December 31, 1905;.. 1... « shee 4-5 Bie 
Adjustments during 1906 in foregoing balance... ....4:-,.0,:....:-. 
Expended for Additional Property and Construction in 1906........ 


Less: Charged off to the following accounts, viz.: 
To Bond: Sinking Piunds o. 0.0 7s ee eee eee $1,406,500.00 
To Depreciation and Extinguishment Funds.... 2,063,052.54 
To Funds provided from Surplus Net Income for 


payment of capital expenditures............ 30,615,844.26 


Expenditures for Stripping and Development at Mines, viz.: 


Balance at December. 31;°19052% < o-fasioslcns man cae « $4,016,985.45 
Net Increase during the year ‘1906. .............. 1,705,355.16 


DEFERRED CHARGES TO OPERATIONS: 

Payments for Advanced Mining Royalties, Exploration Expenses 
and Miscellaneous charges, chargeable to future operations of the 
properties: 27256. SWE aia. Shen to ein Wik et pet NEN Dhs iad Oana ay Sane 

Less: Fund reserved from Surplus to cover possible failure to 
realize: Advanced .Mining Royalties: tit! se.in <<. «sus 


INVESTMENTS: 


Outside Real Estate and. Other Property, ......5.5<.- «245.04 eave aes 


SINKING AND RESERVE FUND ASSETS: 

Cash held by Trustees account of Bond Sinking Funds.............. 

($24,767,500 par value of Redeemed Bonds held by Trustees, not 

treated as an asset.) 

Contingent Fund and. Miscellaneous Assets. .. 0... 0.0 nnsrnunncseseon 
Insurance Fund. Assets (at Cost) ¢ 2s cis ops ps sian oe Rees Le 
Depreciation and Extinguishment Fund Assets (at cost)............. 
Investments (at cost) for Special Construction Fund for Gary Plant... 


CURRENT ASSETS: 
INVENTOTICS® . 5 oc avS ci oe ae OW Wal Saeed aa bee eee 


Bills Recetvable, Gustomers.i\.. > .kou vs op css ai es eee 
Agents’) Balances 3 (o's ei ws. NDE S «Poe 3 Falls ee ae 
sundry. Marketable: Bonds and Stocks ..:. ..<«4:-0is-0 4 bee ee 
Loans On Collateral. ow 2 iden cw pee ole y Pere ie ene ee 


Cash, viz. 
In hand and on deposit with Banks, Bankers and 
Trust Companies subject to cheque............. $62,812,418.49 
Deposits loaned:on call, a..c:-ii9 24 > oe ee eee 2,824,390.35 
Time Certificates of Deposity. .. 25 i vues eae ora 2,000,000.00 


* Inventory valuations include profits accrued to subsidiary com- 
panies on materials and products sold to other subsidiary companies 
and undisposed of by the latter—see contra specific surplus account 
for these profits. The total of all inventories is, however, below the 
actual current market prices, 


3 


UNITED STATES 


$1, 380,031,032.25 
84,823.16 


32,155,146.46 


$1,412,271,001.87 


34,085,396.80 


$1,378,185,605.07 


5,722,340.61 


$4,272,621.94 


2,500,000.00 


$397,287.89 


1,542,398.24 
3,649,979-74 
11,708,499.14 
10,145,788.59 


$119,897,466.73 
58,836,772.50 
4,203,933.30 
672,576.16 


7:720,348.35 
7,600,000.00 


67,636,808.84 


$1,383 907,045.68 


1,772,621.94 
1,617,351.29 


27 443,944.60 


266,567 ,905.88 


$1,681 ,309,769.39 









‘TEEL CORPORATION 
‘EET, DECEMBER 31, 1906. 
LIABILITIES. 


APITAL STOCKS OF SUBSIDIARY COMPANIES NOT HELD BY 


Mae st CORPORATION. (Par Value)... .. 2.0. cece cic cceneone 


j 
“ONDED AND DEBENTURE DEBT: 

United States Steel Corporation 50 Year 5% Bonds... $303,957,000.00 
» United States Steel Corporation 10-60 Year 5% Bonds 170,000,000.00 


$4.73,957,000.00 

Less: Redeemed and held by Trustees of Sink’g Funds 18,956,500.00 
A TS EC gS A i a a 
Subsidiary Cos.’ Bds. (Grtd. by U. S. Steel Corp’n).... $48,624,000.00 
Subsidiary Cos.’ Bds. (Not grtd. by U.S. Steel Corp’n). 64,307,680.41 


$112,931,680.41 
Less: Redeemed and held by Trustees of Sink’g Funds — 5,81 1,000.00 


EERE ERII O05 Ay cc o)'e) coe! clan dio ee isis e is nie wisi her ew os Se 8 
Weepenture scrip, Illinois Steel Company...............c cee eee sence 


SAPITAL OBLIGATIONS AUTHORIZED OR CREATED FOR CAP- 
| ITAL EXPENDITURES MADE (HELD IN THE TREASURY SUBJECT 
TO SALE, BUT NOT INCLUDED IN ASSETS): 
faa). 9. Steel Corporation 10-60 Year 5% Bonds..........0. esc eee eee 
ECTS S700 oe 


Total, not included in General Balance Sheet Assets or Liabilities. . 


MORTGAGES AND PURCHASE MONEY OBLIGATIONS OF SUB- 
SIDIARY COMPANIES: 

RS en 

| EIEN COPS HOATIONS op ictar rec bis Jaleo cee dhs bee ee eee vee pe’e 


SURRENT LIABILITIES: 
Mupentoncount nyvyanlie and Pay Rolls... ke ee cee ee 
Special Deposits or Loans due employes and others................. 
EES a VCE oe rae 
mumricielsteress and Unpresented Coupons.............-c ence nteee 
Preferred Stock Dividend No. 23, Payable February 28, 1907......... 
Common Stock Dividend No. 13, Payable March 30, 1907............ 


Seemann Current Liabilities... 2... ec cle een ctw eecswwes 


SINKING AND RESERVE FUNDS: 
sinking, Depreciation and Replacement Funds...................%. 
General Construction Fund for authorized appropriations............ 
Special Construction Fund for account Gary, Ind., Plant............ 
Contingent and Miscellaneous Operating Funds..................... 
TNE tne oo ts es ie ks Sic la aniie wb aa g eras e's che o be cia wales 


meND SINKING FUNDS WITH ACCRETIONS..................... 


$508,302,500.00 


360,281,100.00 


Oe € Ce Ss ee CS ewe 


$45 5,000,500.00 


I107,120,680.41 
35,069.18 


$30,000,000.00 
10,320,000.00 


$40,320,000.00 


$2,514,626.37 
I,717,500.00 


23,853,579.40 
T,077,292,29 
2,728,361.61 
7,166,344.29 
6,304,919.25 
2,541,512.50 


$38,665,489.73 
3,957,959-15 
26,867,797.89 
7,424,705.80 
3,741,829.28 


6 (6s) 2 Oem Bee 8 ame 


Represented by Cash (and by redeemed bonds not treated as assets—See Contra). 


JNDIVIDED SURPLUS OF U.S. STEEL CORPORATION AND SUB- 
SIDIARY COMPANIES: 
Meters provided in Organization. 2.1... si oe ee eels oe ales 
Balance of Surplus accumulated by all companies from April 1, rgo1, 
MENISCAL OO a. Pee wh wig have o/s avin dining aed elias aie 


Total Surplus exclusive of Subsidiary Companies’ Inter-Company 
Un OU UBT QUEEN ah 9 Coke i Wee lees Me SoG or ganas eRe 
Undivided Surplus of Subsidiary Companies, representing Profits ac- 
crued on sale of materials and products to other Subsidiary Com- 
Senne etiesicpert? factet,s IN VEnNtOries wc asc circ es ee eps oro Oe we he 


$25,000,000.00 


54,556,654.01 


$79,556,654.01 


18,164,060.34 


$868 ,583 ,600.00 


23 400.00 


562,156,249.59 


4,232,120.37 


43 672,009.34 


$1,478,667 ,385.30 


79,750,881.85 
25,164,787.89 


975720,714.35 


$1 ,681,309,769.39 





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. .! 


ADVANCED THEORY AND PRACTICE 
| Yo OF ACCOUNTSs. 


ORGANIZATION AND FINANCE. 
CORPORATIONS. 
ie By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) 


SSE ECTURE: X:; 


SYNDICATES. 
: In GENERAL hye Fie ote a, Cee Gee cen aro eee 117 
: Form OF SYNDICATE AGRERMENT, [0008600 a Ree A 118 
a RatLway BUILDING SYNDICATE......... a ee PURE RS at ei SRN a 118 
| : AccounTING PRINCIPLES AND PROCEDURE... Sy On ave Un 123 
. Bond SYNDICATES. 


COPYRIGHT, I914, BY - 
Homspr St. Crain Pacs, 





ADVANCED THEORY AND PRACTICE 


OF ACCOUNTS. 
ORGANIZATION AND FINANCE. 


CORPORATIONS. 
Pero VERS TT “CLAIR PACE, GP. A. (N. Y.) 
LECTURE X. 


SYNDICATES. 


In General. 


A syndicate is an association of persons, formed for the furtherance 
of some object, usually one involving the contribution, temporarily, of 
large amounts of capital, or the agreement so to contribute. A syndicate 
is not in the nature of a corporation, although ordinarily used as an aid 
to corporate activities. It more nearly approaches a special partnership, 
organized for carrying out a particular undertaking. The attempt is 
usually made, in the agreement constituting the syndicate, to relieve the 
members thereof, inter se, of partnership responsibilities. 

As distinguished from a syndicate, the term promoters is usually 
applied to the persons who assist in organizing joint stock companies 
or corporations. Thus, promoters are those that have to do more par- 
ticularly with the steps preliminary to the organization of a corporation. 
A syndicate is rarely organized for such a purpose. 

The usual form of organization is an agreement between a syndicate 
manager or managers, and certain persons known as subscribers or par- 
ticipants, reduced to writing, and subscribed by the parties thereto, setting 
forth the name and object of the syndicate, and stating the mutual agree- 
ments, undertakings and responsibilities of the managers and participants. 
The syndicate agreement, in order to facilitate its execution by a large 
number of subscribers, may be made in many copies, and each, by the terms 
of the contract, may be deemed an original, with full force and effect. 

The agreement usually provides that the syndicate shall become 
binding upon the subscribers when subscriptions have been received for a 
certain specified amount of capital. 


Copyright, t914, by Homer St. Clair Pace. 


118 


The name and object of the syndicate, and the duties, powers, respon- 
sibilities and compensation of the managers are usually set forth in detail. 
The compensation of the managers is usually fixed as a percentage upon the 
capital of the syndicate. A syndicate secretary may be provided, although 
the appointment of a secretary, and such agents and employees as may 
be necessary for the purposes of the syndicate, usually falls within the 
powers of the syndicate managers. 

There are no requirements in this country, at least, that a syndicate 
shall file reports or disclose the nature of its business or operations. For 
this reason, the syndicate method has advantages in certain classes of 
undertakings. For example, in case a railroad company desires to acquire 
real estate for the purpose of making an improvement, as, for example, 
the building of a station, the entry of the railroad company into the market 
for the real estate would have a tendency to advance prices. Such an 
operation could be better carried out either by individuals, or by an asso- 
ciation of individuals in the form of a syndicate. 

The method of organization by which managers have full power, 
without the action of a board of directors, to carry out the objects of 
a syndicate, while not suited to the needs of permanent business, lends 
itself well, when not abused, to the successful accomplishment of the 
purposes for which syndicates are organized. 

Syndicate enterprises are. often highly speculative, and unsuited, 
for that reason, for permanent organization in the corporate form. 

For the reasons given, and others that may exist, resort is often had 
to the syndicate method of pooling capital, and the treatment of the 
accounts that arise in connection therewith becomes of importance to 
the Accountancy student. 


Form of Syndicate Agreement. 


In order that the student may study the organization of a syndicate, 
and obtain an idea of the powers and responsibilities of the parties thereto, 
and the accounting contingencies likely to arise, it is deemed expedient 
to reproduce herewith a typical syndicate agreement. The one given 
is for a construction syndicate, although, with the objects changed, it 
would answer for any undertaking. It is as follows: 


Railway Building Syndicate. 


THis AGREEMENT, Dated this first day of February, 1900, by and 
between John Doe, hereinafter called the ‘‘ Syndicate Manager,” party 
of the first part, and the syndicate subscribers hereto, severally parties 
of the second part, of whom each is hereinafter termed the ‘‘ Syndicate 


dA 


Subscriber,’’ and all of whom, together with said John Doe, constitute 
the syndicate, to be known as the “‘ Railway Building Syndicate.’ 
WHEREAS, It is proposed by the Syndicate Manager to complete 
certain negotiations now in progress for the purchase provided he can do 
so upon reasonable terms, of the Indiana Railroad, a line of railroad 


miun to0 miles of main track, extending from...... 0.2... 0c.c4 eae eens to 
8 a with certain coal lands, and having completed 
the purchase of said railroad, but not otherwise, to extend said line of rail- 
MM A, orcs ccc sy, wien) eco gered COR CMa tet i as, “sam aiat Abe, a distance of 


about fifty (50) miles, and to purchase rolling stock, if found necessary or 
desirable in the opinion of the Syndicate Manager; and 

WHEREAS, For the purpose of providing the necessary money for the 
purchase and construction of said properties for the purposes herein 
set forth, said Syndicate Manager and the Subscribers hereto wish to form 
a syndicate to advance the necessary money; not exceeding in amount 
$3,500,000; 

Now THIS AGREEMENT WITNESSETH, That, in consideration of the 
premises, and of their mutual agreements, the Syndicate Manager and the 
Syndicate Subscribers hereto severally agree with each other, as follows: 


1. The parties hereto form a Syndicate for the purpose of purchas- 
ing and acquiring the Indiana Railroad, hereinbefore described, and 
having purchased said railroad, but not otherwise, of constructing the 
lines hereinbefore described, and to make such additions and improve- 
ments as the Syndicate Manager may deem desirable, and having acquired 
the same, merging, operating, controlling and disposing of the same as 
may be determined by the Syndicate Manager to be for the benefit of 
such Syndicate. 

2. Each Subscriber hereto, and to any counterpart hereof, shall set 
opposite his name the amount of his subscription to the Syndicate, and 
shall be called upon to pay, or to be liable only for such amount, as shall 
bear to the obligations of the Syndicate, not exceeding $3,500,000, the 
same ratio or proportion as his subscription bears to said maximum obli- 
gation. In the event that more than the aggregate amount of $3,500,000 
is subscribed, the Syndicate Manager may reduce any or all subscriptions 
hereto in such an amount, in his discretion, as shall make the aggregate 
subscription $3,500,000, and in case any such reduction shall be made, the 
Syndicate Manager shall notify the Subscribers whose subscriptions have 
been reduced, of the amount of such reduction. The funds of the Syndi- 
cate shall be applied, used and disbursed by the Syndicate Manager. 

3. The Syndicate Manager agrees to proceed with reasonable dili- 
gence to purchase said Railroad, at such prices and upon such terms of 


120 


payment as shall, in his judgment, be reasonable and the best obtainable 
in the circumstances, and having made such purchase, said Syndicate 
Manager shall deposit with a Trust Company to be selected by him, the 
contract or evidence of such purchase, showing the terms and conditions 
thereof, and thereafter proceed with the construction of the new lines 
above described. 

4. The Syndicate Subscribers irrevocably name and appoint the 
Syndicate Manager their agent and attorney with full power and authority 
to do any and all acts, and enter into and execute any and all agreements 
or other instruments necessary or proper, or by the Syndicate Manager 
deemed expedient in the premises, to carry out and perform the said 
agreement for the purchase of the said Indiana Railroad, and the con- 
struction of the new lines hereinbefore described, and to that end abso- 
lutely to control the property so purchased and constructed as fully in 
all respects as if he were the absolute owner thereof, with power to borrow 
money thereon and pledge the property or any portion thereof as security 
therefor, and to sell and dispose of the same upon such terms as may 
be in his discretion for the interest of this Syndicate, and with like power 
to hold, manage, control and dispose of, in his discretion, any and all 
stocks and securities acquired on any sale or disposal of said property, or 
any part thereof; also, in his discretion, to organize a railway company to 
hold the title of the lines purchased and constructed, in pursuance of this 
contract, and to cause such company to issue such securities as it may 
deem for the interest of this Syndicate, and when issued, to control and 
dispose of, in his discretion any and all securities thus issued. 

5. This Syndicate agreement shall continue in force and operation 
until the first day of February, 1902, unless sooner terminated by the 
Syndicate Manager, in his discretion, and upon notice to the Syndicate 
Subscribers. 

6. The Syndicate Subscribers will, from time to time, and at any 
time, on call of the Syndicate Manager, and to the amount of such call 
or calls, make cash payments on account of their respective subscrip- 
tions hereunder, upon ten days’ written notice by mail from the Syndicate 
Manager. 

All payments hereunder from time to time by the Syndicate Sub- 
scribers shall be made to the Trust Company, designated in such call, 
for the account of the Syndicate Manager. 

Each Subscriber shall, at the time of making each of the payments 
called hereunder, receive a certificate issued by the said Trust Company, 
certifying to the amount of such payment, and the interest of such Sub- 
scriber in said Syndicate, subject to the terms and conditions of this 


121 


agreement. Such certificates shall be in assignable form, and be trans- 
ferable only on the books of said Trust Company by assignment and sur- 
render of such certificate, and, upon such assignment and surrender, a 
new certificate shall be issued in the name of the Transferee. 

_ 7. The Syndicate Manager shall have the sole direction, manage- 
ment, and the entire conduct of the Syndicate, and the enumeration of 
particular or specific powers in this agreement shall not be considered 
as in any way limiting or abridging the general power or discretion intended 
to be conferred upon and reserved to the Syndicate Manager in order to 
authorize him to do any and all things proper, necessary or expedient in 
his discretion to carry out the purposes of this agreement; neither shall 
he be liable under any of the provisions of this agreement, or in or for any 
matter connected therewith, except for want of good faith and the failure 
to exercise reasonable diligence. 

8. The Syndicate Manager shall be entitled to a commission of two 
per centum on the amount of the subscriptions hereto, without any obli- 
gation to share the same with any Subscriber, or to account therefor to 
the Syndicate or to any Subscriber, which shall be the full compensation 
of the Syndicate Manager in managing the Syndicate and supervising the 
construction of the new lines. 

All other expenses of the Syndicate Manager, including counsel fees, 
brokers’ commissions, and all other disbursements and expenses made by 
him in connection with the carrying out of the purposes of this agree- 
ment shall be a charge to the Syndicate, and all profits and losses of the 
Syndicate shall be divided and borne pro rata. The Syndicate Manager 
is to be a Subscriber to the Syndicate, and, to the extent of any such 
subscription or reservation by it, he is to participate in the profits and 
losses to the same extent as other Subscribers. 

Should the Syndicate Manager, in the carrying out of this agree- 
ment, sell and dispose of said railroad properties, or stocks and securities 
received therefor, the net proceeds of such sale shall be distributed pro 
rata to the Subscribers from time to time in the discretion of the Syndicate 
Manager. Should said properties not be sold, but be capitalized by the 
formation of a new company or companies, of which companies the Syndi- 
cate Manager acquires the securities issued, or should said properties or 
any part thereof be disposed of for stocks and securities which are not 
sold by the Syndicate Manager, then, after payment of all expenses and 
commissions accruing under this agreement to said Syndicate Manager, 
and upon the termination of the Syndicate, such securities so acquired 
shall be distributed pro rata to the subscribers hereto or their assigns, 
as provided herein. 


122 


9. Each Syndicate Subscriber hereby ratifies, assents to and agrees 
to be bound by any action of the Syndicate Manager taken under this 
agreement, and agrees to perform all of his undertakings hereunder, 
from time to time, on call of the Syndicate Manager, to the full extent 
of the amount set opposite his name or allotted to him, but he shall be 
liable hereunder solely to the Syndicate Manager or his assigns, and only 
to the extent of his individual participation in the Syndicate. 

Each and every party hereto will, upon reasonable request, execute 
and deliver all further writings which may be necessary or proper to carry 
this agreement into effect. 

The failure of any Syndicate Subscriber to perform any of his under- 
takings hereunder shall not release or affect any other Syndicate Sub- 
scriber. The Syndicate Manager may, in his discretion, by written consent, 
release any Syndicate Subscriber. In case any Syndicate Subscriber 
shall fail to perform any of his undertakings hereunder or be released 
by the Syndicate Manager, other Subscribers may be received by the 
Syndicate Manager and take the share of the Subscriber so failing to 
perform his undertakings or so released. Upon failure of any Syndicate 
Subscriber to perform any of his undertakings hereunder, the Syndicate 
Manager shall have the right, at his option, to exclude such Syndicate 
Subscriber from further interest and participation in the Syndicate, and 
to hold him liable for all damages caused by his failure. 

Nothing contained in this agreement or otherwise, shall constitute 
the Syndicate Subscribers partners with the Syndicate Manager or with 
one another, or render them liable to contribute more than their ratable 
amount as aforesaid, or entitle them to any participation in the results 
or profits of said Syndicate other than as specified in this agreement. 

10. This agreement shall bind and benefit ratably, according to the 
amount of the several subscriptions, not only the parties hereto, but 
their respective successors, survivors, assigns and personal representa- 
tives. An original hereof is to be signed by the Syndicate Manager and 
deposited with the Trust Company so to be designated by him, and 
counterparts may be signed by the Syndicate Subscribers and retained by 
the Syndicate Manager, and all shall be taken and deemed one original 
instrument. 

11. All notices issued by the Syndicate Manager hereunder shall 
be mailed to the addresses of Subscribers as given below opposite their 
respective names. 

The holding of certificates issued by said Trust Company, shall con- 
stitute such holders parties to this agreement, as fully to all intents and 
purposes as if signing the same. 


123 


In Wi1tTNEss WHEREOF, The Syndicate Manager, party of the first part, 
has signed an original hereof, and the Syndicate Subscribers, parties 
of the second part, have subscribed said original, or counterparts hereof, 
as of the day and year first above written. 


NAME ADDRESS AMOUNT 


Accounting Principles and Procedure. 


In the case of a construction syndicate, or in the case of any syndicate 
with large capital and numerous participants, it is best to open a distinct 
and complete set of syndicate books. 

In the Journal, as a basis, it is often desirable to make a complete 
copy of the syndicate agreement, showing the subscribers and the res- 
pective amounts subscribed by each. This preserves and makes available 
in the books themselves, the agreement upon which the accounting must 
rest. The accounts may be opened by an entry debiting the respective 
syndicate subscribers and crediting the syndicate Capital Account. As 
the money is paid in upon calls, Cash is debited and the respective sub- 
scribers are credited. The entries, in such a case, would be: 


Syndicate Agreement, copied in full, as memorandum. 

Do La CS LG 8 geet Od 8 Bd SONS Sara kale nea a Beg 
Mery er ee CADCPUUING Lay wong eniit io hc te whe elie be 

For syndicate subscriptions (account opened for each sub- 
scriber in general or subsidiary ledger). 


MAMIE IST 5, fae Lame chew ew ttuee aie Mek Te ete SW ACS oh ONT 
Pope inti co UW. DoCRIBER Sic. 22k Ooi eee oes 
For payment of call number....of....per cent. 





If, as is sometimes the case, all the money is not called in, there will 
be an overstatement of capital on one side, and an authorized but uncalled 


124 


amount of subscriptions on the other. For this and other reasons it is 
preferable in many cases to charge Subscriptions Called as the calls are 
made, and credit Capital Account, the latter showing at all times the 
amount of subscriptions called for payment. 

Cash is charged and Subscriptions Called is credited as payments are 
received upon the call. The detailed account with the subscriber may be 
operated in a subsidiary ledger, card or otherwise, so that the unpaid calls 
in such record would prove against the balance of the Subscriptions Called 
Account. The entries, in such alternative procedure, would be: 


It is immaterial which method is used although the latter keeps the 
financial records clear of accounts that may never actually enter into 
the accounting record proper. 

In order to keep a proper record of transfers from the data which 
is supplied by the bank or trust company, it is necessary to operate a 
book similar to a stock ledger, giving the name of each subscriber, address, 
amount of subscription, payments thereon, etc. Inasmuch as it is often 
necessary to send out notices, prepare lists of subscribers, etc., a card 
ledger, the units of which can be sorted and handled conveniently, is 
preferable to a bound book or loose-leaf ledger. This is especially true 
where the subscribers are numerous. 

The object of the syndicate is usually effected by the acquisition 
of securities, or the construction of property, paid for by the cash which 
has been received. The treatment of such assets is no different from 
that accorded in other accounts. | 

Thus, the property acquired would be charged at cost, and the entries, 
in principle, would be: 


For amounts paid. gl te 
To. CREDITORS .i32ies oe a 
For amounts owed. 


125 


The assets are ordinarily turned over to the corporation for which 
the property is being acquired or constructed, and paid for in corporate 
securities. The entry, in effect, would be: 


TNS ET DST 09 Sg  CE ee e BEE eNO ett 
oy TELLIER eR DINED WAR 9260150 
MIEN) ORs US DUO ond wines coe uls. « bshediiecalance a ube 

For sale of properties, for which securities were received, 
as follows: 

* * * * * * * 


If the securities received from the corporation exceed the value of 
the assets as they appear upon the syndicate’s books, and it is desired 
to carry such securities at their par value on the books of the syndicate, 
it is necessary to set up an account to receive the excess credit, to be called 
a Bonus Account, or some other name, as the case may require. Discounts 
upon the sales of the securities eventually find their way as a charge or 
offset against this account. 

The liabilities being paid, and the assets reduced to cash, or to some 
other desired basis for distribution, the nominal elements are collected 
in a Profit & Loss Account. The balance of this account is transferred 
to a Subscribers’ Distribution Account, to which has been transferred, 
as a credit, the amount of the syndicate capital. As each subscriber pre- 
sents his certificate for cancellation, he receives his pro rata share of the 
assets, and the Subscribers’ Distribution Account is charged and the 
assets credited with the amount thereof. This is substantially the same 
procedure as obtains in the dissolution of a corporation. 

The expenses, other than the direct cost of properties, is often trans- 
ferred to Cost of Property before the sale of the properties, and are elimi- 
nated in that way. But if there are any nominal debit elements that 
remain on the books, they are a charge against Profit & Loss Account. 
Thus, the entries would be, after determination of the profit, in principle, 
as under: 


126 


PROFITA& GOSS ees eeces ae eete he ee oe eee ee 
CAPITFALG: ACCOUNT ee a ee 

To SUBSCRIBERS’ DISTRIBUTION ACCOUNT.. 
For transfer. 


SUBSCRIBERS’ DISTRIBUTION ACCOUNT. we 
To ASSETSis Of A ee 

For pro rata distribution upon presentation of syndicate cer- 
tificates. 


There may be many contingencies, such as payment to subscribers 
in instalments, the distribution of securities, or the distribution of part 
securities and part cash, but the general principles that apply have been 
sufficiently illustrated. 


Bond Syndicates. 


As indicated by the definition, a syndicate is useful when it is desir- 
able to pledge, for temporary purposes, large amounts of capital. This 
is true in the common form of bond syndicate, known as an underwriting, 
in which a banker bids upon an issue of bonds which he believes can be 
bought and resold to investors at a profit. In many cases the banker 
would not care to undertake, unaided, to buy and market the issue. To 
meet the situation, a few of the banker’s clients who may be interested 
in such a venture, are approached with a syndicate agreement, by the 
terms of which the syndicate agrees to take the bonds from the banker 
at cost, or such other price as may be agreed upon, each subscriber binding 
himself to pay in the amount of his subscription and to take his pro rata 
share of bonds. The banker, however, is constituted syndicate manager, 
with power to sell the securities, and usually receives a commission, regard- 
less of results. Under the power to sell, the syndicate manager will offer 
the bonds for public subscription at a price above the cost to the syndicate. 
It may be that the manager will call in only a part of the subscriptions, 
loaning the balance to the syndicate on the security of the bonds held, 
or negotiate a loan for the syndicate on such security; or he may, in fact, 
advance all the money, and make no call whatever, although this is unusual. 

If the bonds are sold, the manager deducts all expenses and his com- 
mission, pays all loans and distributes the proceeds. The subscribers 
may thus secure a substantial profit with the advance of but a small 
amount of capital. 


227 


On the other hand, in case the bonds cannot be sold at a profit, the 
syndicate may be extended in the hope of a more favorable market. If 
this is not done, or the market does not materialize, the remaining amount 
due upon subscriptions, or such amount as is necessary, is called in, all 
expenses and loans are paid, and the bonds are distributed pro rata. 

The private bankers control the investment market to such an extent, 
that those engaged in financing enterprises recognize, in the majority 
of cases, the futility of attempting to float large issues of securities with- 
out the aid of the banker, and the method indicated is the one commonly 
employed. 

In times of prosperity, when securities sell readily, syndicates are 
profitable, and participation in those formed by successful bankers is 
much sought. In times of market stagnation, the syndicate members 
become loaded with securities through the failure of the public to 
buy. 

So far as the accounting procedure is concerned, if there are but few 
participations, the banker may open an account with each, crediting 
amounts paid in, and charging advances and the cost of securities bought 
for each. The securities are apportioned, and the proceeds applicable 
to each account are credited. When all charges, including expenses, are 
made, and all credits have been entered, the results will show an amount 
due from or to the subscriber. The par of the securities acquired and 
sold for each account may be shown as a memorandum. 

Thus, A, B, and C, as subscribers, and D, as syndicate manager, 
organized a syndicate of $300,000 for the purpose of buying $300,000 
of bonds, to which each of the subscribers agreed to contribute $100,000, 
subject to the call of the manager. A call of 25 per cent. was made upon 
the subscribers, and in response, A, B, and C each paid to D, $25,000. 
The bonds were bought for $270,000, the manager, as a banker, loaning 
to the syndicate the amount necessary, in conjunction with the cash 
already paid in, to pay for the bonds. The bonds, and the syndicate 
agreements to pay in the remaining calls, were held as security to the 
loan. The bonds were sold at a profit sufficient to pay all expenses and 
to return the subscriptions paid in, with a 20 per cent. profit, or $30,000 
net to each subscriber. 

The banker, who was the syndicate manager, could open an account 
in his books with each subscriber, crediting the amount of subscription 
paid in. To each account could be charged the proper proportion of the 
cost of the bonds and expenses. The par of the bonds held as security 
to the advance could be shown in the explanation column of the account. 
As sales were made, the pro rata amounts could be credited to the respec- 


128 


tive accounts, the final credit disclosing the amount to be paid to the 
subscriber. 

This procedure is useful in syndicates with few subscribers, and 
involves proportioning all transactions as they occur. In the majority 
of cases it would be better to open a distinct set of books to cover the 
syndicate transactions. 





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